Mr. Bäckström explains why price stability ought to be a central bank’s principle monetary policy objective Address by the Governor of the Bank of Sweden, Mr. Urban Bäckström, at Handelsbanken seminar in London on 28/1/97. For most central banks today the primary monetary policy objective is price stability. The situation is thus very different from that which prevailed in the earlier period of high inflation. The reorientation of monetary policy stems from people’s growing awareness of an inflationary economy’s harmful effects. The central banks, which are ultimately accountable to their countries’ citizens and the latter’s representatives, would otherwise not have been mandated to focus policy on price stability. In Sweden, for example, 60 per cent of the population see 2 per cent inflation as an appropriate monetary policy objective and only 12 per cent are against this. In my country a low inflation policy therefore has broad political support. I shall be talking today about why price stability ought to be a central bank’s principal monetary policy objective and what this means for economic growth, employment and unemployment. From there I shall consider development in Sweden, the framework of our monetary policy and the current situation. Why price stability? Why should price stability be singled out as a central bank’s overriding objective? Why not attach equal importance to targets for growth, employment and unemployment, particularly as these factors have high priority for economic policy in general? The answer to these questions calls for an understanding of what monetary policy can and cannot do.

The way forward: moving towards an integrated financial market union As I mentioned already, while monetary policy can alleviate deleveraging pressures in crisis times, it cannot address their root causes. In fact, to tackle the underlying problems, a wide-ranging policy response is necessary, inter alia, pertaining to public finances, economic competitiveness and the financial sector. Given the focus of today’s conference, I would like to use the remainder of my speech to consider the last aspect, namely the institutional framework that governs financial markets in European Monetary Union (EMU). In particular, I would like to address two questions: first, what principles should the institutional architecture be based on in order to be effective in avoiding excessive risk-taking and cross-border fragmentation of banking sectors; and second, how do the on-going reform efforts towards a “financial market union” at European level contribute to these aims? In answering the first question, policy-makers should be guided by two criteria: first, economic actors that stand to gain from risky activity should also bear the associated downside risk. To be concrete, a system, in which banks can expect to be bailed out by taxpayers if their investment decisions go wrong, is neither efficient not fair. Second, the  BIS central bankers’ speeches  5  institutional architecture of EMU should achieve a level of integration that is commensurate to the integration of its banking financial sectors. Hence, there should be no systematic cross-country differences in the design and implementation of the rules that govern financial markets.