Consequently, the monetary policy significance of temporary variations in the CPI in the near future should not be exaggerated. However, if long-term inflation expectations and wage formation risk being tangibly affected, we should consider taking measures. How should the exchange rate be taken into account? The Riksbank has no target for the exchange rate, but, in a small, open economy such as Sweden’s, the exchange rate is an important determinant for both inflation and resource utilisation. However, the analysis of exchange rates is an admittedly difficult area. I will explain some of the difficulties involved in this analysis, as well as how they have affected my view of the manner in which the exchange rate should be handled in the monetary policy analysis. The exchange rate’s empirical relationship with interest rate differentials in relation to other countries Let me first clarify my earlier claim that a greater interest rate differential in relation to other countries than that forecast in the Riksbank’s main scenario may lead to a greater appreciation of the krona than that forecast by the Riksbank. The theoretical basis for this is formed by a condition known as uncovered interest rate parity. This is a theoretically fundamental concept and is used frequently. Uncovered interest rate parity says that the interest rate differential between two countries corresponds to the anticipated change in the exchange rate during the period in question.
During several of the initial years of the inflation-targeting regime, the Riksbank used an MCI in its monetary policy analysis.3 Its intention during this period was to demonstrate very clearly that, in a small, open economy, the exchange rate influences inflation and resource utilisation. Today, the Riksbank no longer uses any such index as a summarising measure. One reason for the abandonment of MCI was that it could be interpreted in an excessively mechanistic way: when the exchange rate weakened, MCI tended to be used in a simplified manner as an argument for a higher interest rate, and vice-versa. Considering the wide fluctuations that can take place in the exchange rate over short periods, an MCI in which a large weight is placed on the exchange rate means that very large changes to the interest rate may be demanded to compensate for exchange rate fluctuations.4 The exchange rate pass-through on import and consumer prices is uncertain The price of imported consumer goods is partially determined by the exchange rate. If the krona is weakened, importers must generally pay more in Swedish kronor for goods bought overseas. Importers must choose how to handle this. Should they increase their prices to compensate for the increased purchase prices or should they reduce their margins? The answer to this question depends on a number of factors. In the short term, importers may avoid price changes, as far as this is possible.