And if this were nevertheless to happen, the consequences would probably only be a gradual strengthening of the problems I already see with the current low inflation. The risk that we would face a prolonged period of deflation is partly linked to the view of what monetary policy can achieve. I sometimes see an overly pessimistic attitude to the Riksbank’s ability to influence Swedish inflation rate. Let me discuss this question in conclusion. Monetary policy determines the inflation rate Central banks often talk about the so-called transmission mechanism, that is, how a change in the policy rate affects different aspects of the economy and ultimately the rate of inflation. But how well does this transmission actually work? Does a small open economy like Sweden need to adapt to monetary policy and price trends abroad? Has the transmission mechanism been damaged or weakened by the financial crisis? BIS central bankers’ speeches  9  My perspective on these questions is perhaps rather split. It is clear – and has been so for a long time – that we do not completely understand how the transmission mechanism works. The description we give is simplified and partly based on theories and hypotheses that have not been completely verified by data. But at the same time, empirical studies and practical experience show that the policy rate is a useful tool for influencing economic activity and the inflation rate. It is of course true that a small open economy like Sweden is dependent on developments abroad.

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