There was a happy feeling that, at last, a perennial monetary regime had been found, well-tailored to the characteristics of a modern market economy. Financial markets were efficient and the zero lower bound and liquidity trap appeared to be no more than historical curiosities. With hindsight, of course, we can see now that this “ideal” economy may never have existed. The Great Moderation was as much a product of “good luck” (brought by disinflationary effects of globalisation) than good policy. Monetary stability is a necessary but not a sufficient condition of financial stability, because capital markets are not always and necessarily efficient. And downward financial spirals may quickly bring our economies to the point where interest rates can no longer be used as effective tools. Therefore, as the crisis unfolded, central banks responded by taking unprecedented measures and, in the process, underwent three major changes A diversification of their interventions. In order to both: Unclog financial markets (both private and public). This involved exceptional liquidity provision to banks as well as temporary purchases of assets, both private and public. Circumvent the zero lower bound and bring down real long-term interest rates through purchases of government bonds, and/ or interest rate guidance. As a consequence, central banks’ balance sheets expanded by a factor of three, dramatically increasing their role in financial intermediation and sometimes raising concerns, at least in some quarters, about the possible inflationary impactTogether, this diversification and the increase in size have created more complex interactions with fiscal policies.
Central banks have one or sometimes two well-defined tasks, namely to maintain stable prices and often also to safeguard the stability of the financial system. For that purpose, the central banks have primarily one instrument, the instrumental rate, sometimes supplemented by other means of exercising control. The objectives for central bank activities are thus simple and clear, their arsenal of tools is limited. This cannot in any way be compared with the complex tasks of governments, their decisionmaking situations with conflicting goals and a continually changing agenda. In Sweden, a small part of the public policy has been removed from the Government and the Riksdag to the Riksbank by the Riksdag’s own decision, namely responsibility for stable prices and financial stability. Everything else remains on the Government and Riksdag. The tasks and policies of the central banks are thus not in any way comparable with government policy as regards importance and degree of complexity. However – having said this – I should like to strongly emphasise the importance of there being a high level of confidence in the Riksbank. It can perhaps be said that the most important variable we have to comply with is the public’s inflation expectations. After all, it is these expectations that reflect confidence. If disturbances affect the economy through, for instance, an oil price shock, so that inflation exceeds the Riksbank’s target of 2 per cent, a return to the target can take place more quickly if public expectations remain at the 2 per cent target.