Thirdly, somewhat tighter monetary policy than otherwise would be able to counter an over-optimistic pricing of financial assets and properties. The second argument is therefore based on the idea that the central banks’ normal forecast horizon of two years is too short, while the third argument is based on the assumption of irrational expectations. Lengthening the forecast horizon is relatively simple in principle, but in practice it is more difficult of course. Especially if the models used have some of the shortcomings I mentioned earlier. The third argument regarding irrational expectations is more difficult to adopt a position on. If we seriously believe that it is relevant, a large part of the foundation for the analysis and recommendations on which central banks today base their policy collapses at the same time. However, “Irrational expectations” could be a result of insufficient availability of information. Therefore, it cannot be ruled out that central banks, by pointing out potential problems associated with high debt levels, can contribute to reflection among those agents that otherwise would undertake commitments that they would not be able to meet when conditions change or in banks that otherwise would take on excessive credit risks. Influencing behaviour in this way by spreading information is an important idea behind the Riksbank’s Financial Stability Reports. Those that maintain that there is too much uncertainty to dampen a price rise via interest rate adjustments are thus of the opinion that it is better to wait until asset prices start to decline.
According to these theories there is some scope for monetary policy to take account of the output gap without necessarily threatening price stability in the slightly longer term. An important condition for this, however, is that there is considerable confidence in the central bank’s aim to focus on long-term price stability. In the long run, monetary policy cannot determine the real interest rate but in the short term the real interest rate can be influenced and deviate from its long-term equilibrium position. An increasing number of central banks have adopted inflation targets during the 1990s. The introduction of statutory price-stability objectives, independent central banks, transparency and - not least - regulations that give long-term sustainability in the public finances have also been important means for increasing credibility for the ability of economic policy to maintain price stability. 1  2  E.g. Woodford, Claridas  BIS Review 40/2004  In Sweden, the Riksbank adopted an inflation target as early as 1993. According to this target, inflation measured in terms of the change in consumer prices should be 2 per cent per year, with a tolerance for deviations of +/- 1 percentage point. As monetary policy does not have an immediate impact, interest rate decisions are normally governed by forecasts of inflation one to two years ahead. To avoid the economic costs of excessively sharp fluctuations in economic activity, the Riksbank many decide not to take account of price effects that are judged to be temporary.