Lars E O Svensson: Why a lower repo rate path?
Speech by Prof Lars E O Svensson, Deputy Governor of the Sveriges Riksbank, at Umeå
University, Umeå, 24 February 2010.
* * *
The opinions expressed herein are my own and are not necessarily shared by other members of the Riksbank's
Executive Board or staff. I would like to thank Hans Dillén, Karolina Ekholm, Per Jansson, Pernilla Meyersson,
Staffan Viotti and Svante Öberg for their valuable comments. Hanna Armelius has contributed to this speech.
In this speech, I would like to explain why I entered a reservation the most recent monetary
policy meeting and justify why I preferred a lower repo rate. I will also explain why I consider
that mean squared gaps should be used, to a greater extent, as a measure of the extent to
which monetary policy has succeeded in stabilising inflation around the inflation target and
resource utilisation around a normal level. Such measures entail a new step towards a more
transparent and systematic monetary policy.
The Sveriges Riksbank Act and the preparatory work for it specify that monetary policy
should be directed towards stabilising inflation around the inflation target and resource
utilisation around a normal level. The lower repo rate path I advocated at the most recent
monetary policy meeting would provide a better outcome for both inflation and resource
utilisation, with both higher resource utilisation and CPIF inflation closer to the target. Such
an interest rate path would not entail any problems for financial stability or the functionality of
the financial markets. Housing prices and mortgages do not comprise stability problems and
should not affect monetary policy. Any future problems on the housing markets, or, indeed,
any future problems with financial stability whatsoever, can best be managed through
regulation and supervision. The repo rate is an altogether too blunt and unsuitable instrument
to be used for any other purpose than stabilising inflation around the inflation target and
resource utilisation around a normal level.
Monetary policy should be directed towards stabilising both inflation and resource
utilisation
According to the Sveriges Riksbank Act, "the objective for monetary policy is to maintain
price stability". The objective is thus price stability. The Riksbank has specified this as an
inflation target of 2 per cent. This means that monetary policy should stabilise inflation
around the inflation target.
Furthermore, in the preparatory work for the Sveriges Riksbank Act (Prop. 1997/98:40), it is
stated that "as an authority under the Riksdag, the Riksbank, without prejudice to the price
stability market, should furthermore support the goals of general economic policy with a view
to maintaining a sustainable level of growth and high rate of employment". How should this
be interpreted? What is the best contribution monetary policy can make towards maintaining
a sustainable level of growth and high rate of employment? It is to stabilise resource
utilisation around a normal level.
Considering the price stability objective stipulated in the Sveriges Riksbank Act and the
stance taken in the preparatory work, it can be concluded that monetary policy should be
aimed at stabilising inflation around the inflation target and resource utilisation around a
normal level. This is called flexible inflation-targeting in the terminology I proposed in a
number of papers published in the 1990s (Svensson 1999). This is, incidentally, completely
in line with the stance adopted by the parliamentary Committee on Finance in 2007, in its
comments on the evaluation of monetary policy in the period 1995-2005 by Francesco
Giavazzi and Frederic Mishkin (2006/07:FiU27): "The Committee maintains that Swedish
monetary policy should be conducted in a flexible way and should aim to stabilise the
development of inflation, employment and production."
This being so, some people may wonder: Wouldn't it be better to have a level of resource
utilisation that is higher than normal? Shouldn't monetary policy be aimed at achieving a
higher level of resource utilisation than normal? Well, you may think so - but 40 years of
practical experience and 30 years of theoretical and empirical research have produced
overwhelming evidence that monetary policy alone cannot bring about a higher than normal
level of resource utilisation. Making attempts through a more expansionary monetary policy
will not lead to success in increasing resource utilisation and employment. The only result to
be achieved will be higher inflation than desired - that is to say that, on average, the inflation
target will be exceeded. Consequently, for monetary policy, the highest level of resource
utilisation that is sustainable over the longer term is the normal level. Other economic
policies than monetary policy, such as labour market policy and structural policies improving
the workings of the economy and the degree of competition, are needed to raise production
and employment above the level that today is normal for these variables.
Consequently, if the inflation target is given priority, a higher than normal level of resource
utilisation cannot be sought in monetary policy. Some people may believe that priority to the
inflation target may entail ignoring the real economy entirely and only caring about stabilising
inflation. This is an altogether too narrow approach and characterises a so-called "inflation
nutter", to use Mervyn King's striking expression. It is called strict inflation targeting in the
terminology I proposed.1 Giving priority to the inflation target does not, therefore, mean that
monetary policy should not stabilise resource utilisation, but, instead, that it should stabilise
resource utilisation around a normal level, rather than a higher one.
The same concept can be expressed with different words. When it comes to the average
level of inflation and resource utilisation, there is only one numerical target, namely the
inflation target. There is no independent numerical target for resource utilisation. Rather, the
average level for production and employment is determined by the workings of the economy,
stability
not by monetary policy. When it comes to the around these levels, there is an
objective for both, namely that of stabilising both as much as possible, and of trying to
achieve a reasonable balance between stability in inflation and resource utilisation when it is
not possible to stabilise both completely.
As far as I am aware, this interpretation of the Sveriges Riksbank Act and its preparatory
work is now generally accepted.
A lower repo rate path achieves a better outcome for inflation and resource utilisation
At the most recent monetary policy meeting, I shared the view in the monetary policy report
regarding economic developments in Sweden and abroad, but I expressed a reservation in
favour of a lower repo rate path than that presented in the main scenario. I argued that a
lower interest rate path will lead to a much better outcome for inflation and resource
utilisation without causing any problems to the functioning of the financial markets or to
financial stability. How did I arrive at this stance?
If a conflict should arise between stabilising inflation and stabilising resource utilisation, then
a well-balanced monetary policy involves a reasonable compromise between the stability of
inflation and the stability of resource utilisation. If there is no such conflict, things are much
simpler. Then it is merely a question of finding the repo rate path that will stabilise both
inflation and resource utilisation. In the current situation it can actually be claimed that there
is no conflict.
Figure 1
Monetary policy alternatives, February 2010
a. a. Alternative Alternative repo-rate repo-rate paths paths d. d. CPIF CPIF
5.0 5.0 4.0 4.0
Per Per cent, cent, quarterly quarterly averages averages Annual Annual percentage percentage change change
4.0 4.0
3.0 3.0
3.0 3.0
2.0 2.0 2.0 2.0
1.0 1.0
1.0 1.0
0.0 0.0
0.0 0.0
-1.0 -1.0
08 08 09 09 10 10 11 11 12 12
08 08 09 09 10 10 11 11 12 12
b. b. Mean Mean squared squared gaps gaps (output) (output) e. e. Output Output gap gap
1.0 1.0
8.0 8.0
Per Per cent cent
Higher Higher
0.0 0.0
6.0 6.0
Main Main
-1.0 -1.0
Lower Lower
-2.0 -2.0
4.0 4.0
-3.0 -3.0
Production Production
2.0 2.0
-4.0 -4.0
-5.0 -5.0
0.0 0.0
08 08 09 09 10 10 11 11 12 12
0.00 0.00 0.20 0.20 0.40 0.40 0.60 0.60 0.80 0.80
CPIF CPIF
c. c. Mean Mean squared squared gaps gaps (hours) (hours) f. f. Hours-worked Hours-worked gap gap
2.0 2.0
4.0 4.0
Per Per cent cent
1.0 1.0
3.0 3.0
Higher Higher
0.0 0.0
2.0 2.0
Hours Hours
-1.0 -1.0
Main Main
1.0 1.0
-2.0 -2.0
Lower Lower
-3.0 -3.0
0.0 0.0
08 08 09 09 10 10 11 11 12 12
0.00 0.00 0.20 0.20 0.40 0.40 0.60 0.60 0.80 0.80
CPIF CPIF
Main Main Main Lower Lower Lower Higher Higher Higher
To determine which repo rate path is most appropriate, a comparison must be made of the
forecast for inflation and resource utilisation for alternative repo rate paths. Such a
comparison is presented in Figures 2.13-2.15 at the end of Chapter 2 of the Monetary Policy
Report. I present a similar comparison here in Figure 1.
Figure 1 shows the consequences of alternative repo rate paths for the forecast for inflation
and resource utilisation. The different repo rate paths are shown in panel a. In the middle is
the main scenario's repo rate path - the repo rate path that the Executive Board majority
chose at the meeting in February. Panel d shows the equivalent forecasts for CPIF inflation.2
Panels e and f show equivalent forecasts for two measures of resource utilisation, the output
gap in panel e and the hours gap in panel f.
Panels b and c in Figure 1 also show the mean squared gaps, which were introduced in an
article in the Monetary Policy Report in October 2009.3 The mean squared gap for inflation
measures the deviation between the inflation forecast and the inflation target or, more
precisely, the mean squared gap between the inflation forecast and the inflation target during
the forecast period. A lower mean squared gap for inflation entails a forecast of inflation
closer to the inflation target, that is a better stabilisation of inflation around the inflation target.
The mean squared gap for resource utilisation, measured as the output gap or the hours
gap, measures the deviation between the forecast for resource utilisation and normal
resource utilisation - more precisely, as the average squared gap during the forecast period.
A lower mean squared gap for resource utilisation thus entails a better stabilisation of
resource utilisation around a normal level.
Figure 2
Output gap for a number of forecasters
Per cent
6 6
4 4
2 2
0 0
-2 -2
-4 -4
The Riksbank, Feb -10
NIER, Dec -09
-6 -6
European Commission, Nov -09
OECD, Nov -09
-8 -8
IMF, Oct -09
Ministry of Finance, Jan -10
-10 -10
00 01 02 03 04 05 06 07 08 09 10 11 12
The gaps for output and hours worked are calculated as the difference between actual and
"potential" levels. The Riksbank's estimates and forecasts for potential output and hours
worked are inadequate and in great need of improvement and development.4 Such
development work is currently underway. These measurements of resource utilisation are
thus not particularly reliable. However, according to all available measurements, there is no
doubt that resource utilisation is and will remain very low during the forecast period. Other
forecasters' output gap forecasts are shown in Figure 2. Several of the forecasts from other
forecasters indicate an even lower level of resource utilisation than the Riksbank's estimate.
Figure 1 here or Figures 2.13-2.15 in the Monetary Policy Report summarise the essence of
the monetary policy decision. What monetary policy alternative shall we choose? Which repo
rate path shall we choose: the one in the main scenario, or a higher or lower repo rate path?
My firm opinion is that a large part of the monetary policy decision-making process and
discussion should centre on monetary policy alternatives and their advantages and
disadvantages. I fear that the decision process will otherwise fix too quickly and too
uncritically on one particular alternative instead of carefully and meticulously considering
several alternatives, choosing the best one, and very clearly describing why one particular
interest rate decision was made and not another. As the Riksdag Committee on Finance
states in its report in 2007: "A flexible monetary policy requires, in the Committee's view, a
high degree of transparency and that the Riksbank is very clear about why the various repo
rate decisions have been made. This is also a prerequisite for the possibility to examine and
evaluate monetary policy." In my opinion, this requires a methodical and detailed discussion
of the various monetary policy alternatives, together with the reason why one of them should
be preferable to the others.
The effects of a changed repo rate path on the forecast for inflation and resource utilisation
are calculated with the help of the Riksbank's model Ramses. In particular, they have been
calculated using so-called expected deviations from the main scenario's repo rate path. This
corresponds to a situation in which the Riksbank clearly and transparently announces an
alternative repo rate path that it intends to follow and that affects market expectations and
thus inflation and the real economy.5
The deviations from the main scenario's repo rate path that are shown in these graphs entail
a reduction or an increase in the repo rate by 0.25 percentage points over four quarters. After
this, the alternative repo rate paths gradually return to the main scenario's repo rate path in
accordance with the Riksbank's historically-estimated reaction function.
Figure 3 shows the consequences, expressed as a percentage or percentage per year, of a
reduction of the repo rate path by 0.25 percentage points over four quarters on quarterly
inflation, the real repo rate, the real exchange rate, four-quarter inflation, production and
hours worked. The solid curves show the effect of an anticipated reduction, while the dashed
curves show the effect of an unanticipated reduction.6 We see that, all else being equal, such
an anticipated reduction of the repo rate leads to an increase in inflation of just over
0.4 percentage points, an increase in output and the output gap of just over 0.4 per cent or
percentage points, respectively, and an increase of the number of hours worked of
approximately 0.35 per cent. If employment varies one-to-one with hours worked, which is
realistic in a year or a couple of years' time, employment will then increase by approximately
0.35 per cent.
Figure 3
The effects of expected and unexpected deviations
from the repo rate path of 0.25 percentage points over four quarters.
Repo Repo rate rate 1-quarter 1-quarter inflation inflation
0,5 0,5 0,5 0,5
0,5 0,5 0,5 0,5
0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0
-0,5 -0,5 -0,5 -0,5 -0,5 -0,5 -0,5 -0,5
0 0 4 4 8 8 12 12 16 16 20 20 0 0 4 4 8 8 12 12 16 16 20 20
Real Real repo repo rate rate Real Real exchange exchange rate rate
0,5 0,5 0,5 0,5 1,5 1,5 1,5 1,5
1,0 1,0 1,0 1,0
0,0 0,0 0,0 0,0
0,5 0,5 0,5 0,5
-0,5 -0,5 -0,5 -0,5
-1,0 -1,0 -1,0 -1,0 0,0 0,0 0,0 0,0
0 0 4 4 8 8 12 12 16 16 20 20 0 0 4 4 8 8 12 12 16 16 20 20
4-quarter 4-quarter inflation inflation GDP GDP
0.5 0.5 0.5 0.5 0.4 0.4 0.4 0.4
0.0 0.0 0.0 0.0 0.2 0.2 0.2 0.2
-0.5 -0.5 -0.5 -0.5 0.0 0.0 0.0 0.0
0 0 4 4 8 8 12 12 16 16 20 20 0 0 4 4 8 8 12 12 16 16 20 20
Hours Hours worked worked
0.4 0.4 0.4 0.4
Anticipated Anticipated Unanticipated Unanticipated
0.2 0.2 0.2 0.2
Note. Note. All All x-axes x-axes refer refer to to quarters. quarters.
0.0 0.0 0.0 0.0
0 0 4 4 8 8 12 12 16 16 20 20
0.35 per cent of an estimated potential employment rate of, conservatively, 93 per cent of a
labour force of approximately five million is equivalent to over 16 000 jobs. Calculating on the
basis of 93 per cent thus entails assuming a rather high figure for long-term unemployment of
7 percent. An increase of over 16 000 jobs is thus not very far from the middle of the
preliminary range of 10 000 to 25 000 jobs saved that I mentioned at the Monetary Policy
Meeting in October. To sum up, a reduction of the repo rate path by 0.25 percentage points
over four quarters will thus give, all else being equal, an increase in inflation of just over
0.4 percentage points and, if employment varies one-to-one with hours worked, an increase
in employment of approximately 0.35 per cent, which is equivalent to an estimated figure of
over 16 000 jobs.
We see in Figure 3 that the consequences of an unanticipated reduction of the repo rate are
less than those of an anticipated reduction. In such a case, hours worked increase by
0.23 per cent, equivalent to just under 11 000 jobs, when calculated on the same basis.
These estimates are unbiased estimates and forecasts of the effects of a lower repo rate
path. The actual effect may be larger or smaller. It is possible that the effects of the repo rate
on the economy are smaller than normal when the repo rate is close to zero. It is also
possible that a reduction of the repo rate path, in a situation in which the market's repo rate
expectations remain higher than the repo rate path, can have a larger than normal
downwards effect on repo rate expectations, thus increasing the effects on the economy. In
the absence of more detailed information on the effect that may be dominant, it does not
seem unreasonable to assume that the effects of a reduction of the repo rate path will be of a
normal scale.
These figures and the estimated effects of a repo rate reduction are not the final word. Of
course the future will bring further developments of Ramses and other models, more
empirical estimates and new experience, which will lead to the revision of these figures.
However, I would claim that these figures are the latest and best word on the basis of the
information and knowledge currently available, and therefore provide the best basis for a
decision right now.
Similarly, the mean squared gaps are perhaps not the last word when it comes to measuring
the Riksbank's target achievement. However, it is fair to claim that is the best way we have
found so far of me assuring target achievement, that is, the extent to which the Riksbank has
succeeded stabilising both inflation around the inflation target and resource utilisation around
a normal level.
I consider Figure 1 very clarifying. To summarise: It clearly shows that the lower repo rate
path provides both a higher forecast for inflation measured in terms of the CPIF that is closer
to the inflation target (which is shown in panel d) and a higher forecast for resource utilisation
measured in terms of the output gap (panel e) or the gap for hours worked (panel f), which
even with the lower repo rate is low but not as low as in the main scenario. Thus, a repo rate
path which is lower than that in the main scenario stabilises both inflation and resource
utilisation better. Panels b and c also show that the mean squared gaps for inflation, output
and hours worked are lower under the lower repo rate path.
Is there any reason not to choose the lower repo rate path?
One might think that if one nevertheless does not choose the lower repo rate path one must
have strong reasons for this. So what does the Monetary Policy Report, which, of course,
represents the view of the majority of the Executive Board, say about the various monetary
policy alternatives? After Figures 2.13-2.15 are presented, there is a sentence on page 38
that states "Whether or not the repo rate levels set in these scenarios would lead to a better
or worse development of the economy than that portrayed in the main scenario is not a
simple question
to answer" (my italics). Speaking for myself, I actually find it, on the contrary,
a very simple question to answer. The lower repo rate path provides a better development,
while the higher provides a worse.
The next paragraph mentions different measures of resource utilisation and emphasises the
uncertainty of these measures. In this case, however, all measures of resource utilisation
give the same answer. The lower repo rate path is better, and the higher is worse. Other
forecasters than the Riksbank, such as the National Institute of Economic Research, the
Ministry of Finance and the OECD, have even lower estimates of resource utilisation than the
Riksbank, as can be seen in Figure 2. The paragraph on resource utilisation thus provides no
argument against choosing the lower repo rate path.
The following paragraph states that it is difficult to know how economic agents will act and
how financial markets will function when interest rates are very low. However, I do not know
of any information pointing to economic agents acting differently or paradoxically when
interest rates are low, or why this should have such drastic consequences that it is allowed to
dominate over other considerations. Interest rates have been very low in many countries for
more than a year; moreover there have been much lower interest rates in several other
countries than in Sweden. In Switzerland they have had policy rates of a couple of basis
points. As pointed out in the Economic Commentary "The lower limit of the Riksbank's repo
rate" (Beechey and Elmér, 2009), which was published on the Riksbank's website last
autumn, one cannot find any problems in the financial markets that can be attributed to low
interest rates.
Since then a few more months have passed. Both the Monetary Policy Department and the
Financial Stability Department at the Riksbank closely follow developments in the financial
markets and have very good information about them. There are still no signs that low interest
rates have entailed any problems with regard to financial stability or the functioning of the
financial markets. The profitability of the major banks, in the form of the net interest margin,
has been stable and their share of deposits from households has not changed noticeably.
The redistribution of capital on the fund market has also been moderate. The financial
infrastructure has not been affected by any problems during the period of low interest rates
and resilience against disruptions of the financial infrastructure is deemed to be high.
The final paragraph on page 28 mentions risks linked to exaggerated lending and rapid
increases in house prices. These risks have been closely studied in both the Riksbank's
most recent Financial Stability Report and by Finansinspektionen (the Swedish financial
supervisory authority) in its report on the Swedish mortgage market and bank lending
(Finansinspektionen, 2010). The unequivocal and certain conclusion based on very detailed
data, studies and stress tests is that the housing market and credit granting do not at present
entail any problem for financial stability. If such problems were to arise at some point in the
future, Finansinspektionen has suitable instruments, in the form of regulations regarding
leverage, amortisation and housing cost calculations. However, the repo rate is a very blunt
and thus less suitable instrument for affecting potential risks of this sort. Consequently, there
does not seem to be any reason to allow house prices and credit granting to affect the repo
rate decision now.
At the monetary policy meeting, a number of members of the Executive Board stated that a
possible future fall in house prices may have a negative impact on consumption in the future.
This would lead to a fall in aggregate demand, with negative consequences for future
resource utilisation and inflation. However, if one believes this, it should also be considered
in the assessment of the influence of alternative repo rate paths on the forecasts for inflation
and resource utilisation, and it should only be allowed to affect monetary policy in such a
case. These forecasts are mean forecasts, and some probability of a negative outcome has
a negative impact on the mean. In this sense, the forecasts are "risk-adjusted". As usual, it is
necessary to filter all information through the forecasts to determine whether or not it should
affect monetary policy. As usual, it is necessary to consider all information, where, in
practice, the assessment of effects not covered by models is of great significance. If
something cannot be considered to affect the expected value of future inflation and resource
utilisation, then monetary policy does not need to react to it.7
Kohn (2006, 2008) mentions three conditions that should be fulfilled before central banks
implement "extraordinary measures" to handle possible asset price bubbles, such as the
unsustainable development of housing prices: "First, policymakers must be able to identify
bubbles in a timely fashion with reasonable confidence. Second, a somewhat tighter
monetary policy must have a high probability that it will help to check at least some of the
speculative activity. And third, the expected improvement in future economic performance
that would result from the curtailment of the bubble must be sufficiently great." As these
conditions are very seldom fulfilled in practice, it is very seldom that the issue arises, in
practice, of allowing asset prices to influence monetary policy.8
It has occasionally been claimed that a central bank should be cautious as regards lowering
the interest rate to very low levels, as this would be venturing into unfamiliar waters. I object
strongly to "unfamiliar waters" being an argument against cutting the repo rate. It is exactly
by daring to move out into unfamiliar waters, with historically low interest rates right down to
a few basis points, and with large unconventional measures, that the world's central banks,
including the Riksbank, have succeeded in preventing the major crisis from becoming the
Great Depression mark two.
It has also been claimed that the discussion on the lowest level of the repo rate was resolved
at the monetary policy meeting in July 2009 and that there is no reason for a reassessment.
In July, the majority of the Executive Board stated in a press release and in the Monetary
Policy Report that "the Riksbank's assessment is that, after cutting the repo rate to 0.25 per
cent, it will have reached its lowest level in practice". Firstly, as I expressed at the meeting in
July, in my opinion, this statement was a mistake. It goes against the commonly accepted
principle that the repo rate path is "a forecast, not a promise". In practice, the statement is a
promise not to lower the repo rate further. Furthermore, the statement implies that the repo
rate path cannot normally be a mean forecast, as all risk is upside risk and the mean is then
higher than the repo rate path. In this case, the actual monetary policy will be more
contractionary, exactly in a situation in which a more expansionary monetary policy is
desired.9 Secondly, in my opinion, it is a mistake to continue to accept this lower limit and not
thoroughly reassess it at every monetary policy meeting, in particular as later information and
analysis indicates that very low interest rates do not give rise to any problems with financial
stability or the financial infrastructure.
It has also been claimed that it would be wrong to lower the repo rate path during an
economic upturn, even if a very deep recession is still prevailing. I do not understand this
argument. Whether it is right or wrong to lower the repo rate path should, in my opinion, be
determined solely by whether the stabilisation of inflation and resource utilisation would be
improved or impaired by a lower repo rate. I cannot discern any reason for it to be less
important to stabilise inflation and resource utilisation as efficiently as possible now that the
economy has touched bottom and the prevailing deep recession has become somewhat less
deep.
Transparency and mean squared gaps
Let me finally address the role of the mean squared gaps in improving the transparency of
monetary policy. Monetary policy has a major impact on both inflation and the real economy.
The Executive Board bears a considerable responsibility for its decisions and their
consequences for inflation and the real economy. It is important that the Riksdag, the
Committee on Finance and external analysts can examine and evaluate monetary policy and
assess whether the Executive Board has made the right decision and whether monetary
policy is well balanced. As the Committee on Finance says in the comments mentioned
above: "A flexible monetary policy requires, in the Committee's view, a high degree of
transparency and that the Riksbank is very clear about why the various repo rate decisions
have been made. This is also a prerequisite for the possibility to examine and evaluate
monetary policy."
In order for the Riksbank to be able to be "very clear" about why the various repo rate
decisions have been made, I believe it to be necessary to discuss and assess various
possible monetary policy alternatives and their consequences for inflation and the real
economy. A specific decision can best be justified by comparing it to the alternatives. It is
thus a question of clarifying the reasonable and possible repo rate paths that exist and what
consequences these alternatives paths have on the forecast for inflation and resource
utilisation.
Being able to measure and quantify target achievement is a major advantage. But how can
the degree to which monetary policy has succeeded in stabilising inflation and resource
utilisation be measured? The mean squared gap for inflation is a natural measure of the
stability of inflation around the inflation target. The mean squared gap for output is a natural
measure of the stability of the output gap and thus of the stability of resource utilisation
around a normal level.
Looking at Figure 1, it could be claimed that the mean squared gaps in panels b and c do not
tell us anything of significance, as it is obvious from panels d, e and f that the lower repo rate
path leads to a better outcome. However, the situation is unusual in that the main scenario is
not efficient - that is, that it is possible to find another repo rate path that better stabilises
both inflation and resource utilisation. A more normal situation is one in which a balance
must be struck between prioritising the stabilisation of either inflation or resource utilisation.
Such a situation prevailed for Norges Bank in March 2005, for example. In Figure 4, I present
the mean squared gaps calculated on the basis of the alternative policy rate paths and
equivalent forecasts for inflation and resource utilisation presented in Norges Bank's
monetary policy report from March 2005. The policy rate path then chosen depends upon the
weighting placed by the central bank upon stabilising the output gap, as opposed to

stabilising inflation (this weight is usually denoted by ). For example, in an assessment of
monetary policy, this becomes an issue of whether the central bank attaches a reasonable
relative weight to the stabilisation of resource utilisation and whether the central bank is
reasonably consistent over time.10
The numerical inflation target has signified great progress for practical monetary policy and
made it possible to measure and evaluate the target achievement of monetary policy in a
much more effective manner than before. However, the fact that monetary policy is not just
directed towards stabilising inflation, but also towards stabilising resource utilisation has, in
the absence of quantitative measures of stability in these variables, made it difficult to
measure and evaluate target achievement in this stability dimension. However, the
quantitative measure implied by the mean squared gaps makes it possible to measure and
evaluate this target achievement. Using the mean squared gap may entail a progress similar
to the earlier introduction of the numerical inflation target. Following the introduction of
published policy rate paths, this is another step towards a better and more effective monetary
policy and better opportunities to evaluate monetary policy's target achievement.
Figure 4
Monetary policy alternatives for Norges Bank, March 2005
Alternative Alternative Alternative repo-rate repo-rate repo-rate paths paths paths CPI-ATE CPI-ATE CPI-ATE
8,0 8,0 8,0 8,0
3,0 3,0 3,0 3,0
Per Per Per cent, cent, cent, quarterly quarterly quarterly averages averages averages Annual Annual Annual percentage percentage percentage change change change
6,0 6,0 6,0 6,0
2,0 2,0 2,0 2,0
4,0 4,0 4,0 4,0
1,0 1,0 1,0 1,0
2,0 2,0 2,0 2,0
0,0 0,0 0,0 0,0
0,0 0,0 0,0 0,0
02 02 02 02 03 03 03 03 04 04 04 04 05 05 05 05 06 06 06 06 07 07 07 07 08 08 08 08 02 02 0