lars nyberg : the repo rate - spring 2002 speech by mr lars nyberg, deputy governor of sveriges riksbank, to the swedish taxpayers ’ association in malmo and kristianstad, 22 april 2002. * * * i should like to begin by thanking you for the invitation to this discussion and the opportunity to develop some ideas on the swedish economy as it looks in spring 2002. i shall start with the riksbank's most recent executive board meeting on 18 march, where we decided to raise the repo rate by 0. 25 percentage points to 4. 0 per cent. it may seem as though the interest rate hike did not come at the most appropriate point in time, as economic activity is still weak. why did we raise the rate so quickly and before most other central banks had done so? moreover, we, in common with most of the analysts in the market, expect the inflation rate to fall during the spring. why did we raise the repo rate when inflation is on its way down? these are questions that i shall try to answer today. some analysts also consider that the riksbank has made a sudden u - turn in its assessment of inflation and so i thought i would explain a little about how our view has changed and why. however, it was not actually a major change and cannot really be regarded as a total u - turn. why was the repo rate raised when inflation is on its way down? the riksbank has been given a statutory task of maintaining price stability and promoting a safe and efficient payment system. the riksbank has specified the monetary policy objective as a rate of increase in consumer prices, measured as cpi inflation, of 2 per cent, with a tolerated deviation interval of plus / minus one percentage point. the most important instrumental rate, the repo rate, is the instrument normally used by the riksbank to maintain price stability. our monetary policy strategy can be described in a simplified manner using the rule of thumb that when an assessment indicates that inflation one to two years ahead will deviate from the target level, the instrumental rate is adjusted. the riksbank's assessment of future inflation is communicated, for instance, in the inflation reports published four times a year. the riksbank has chosen to maintain the inflation target in a medium - term perspective. one reason for this is that monetary policy affects inflation with a significant time lag. an attempt to ensure that inflation also develops in line with the target

that the riksbank constantly adapts the instrumental rate to ensure that the inflation forecast 1 - 2 years ahead is in line with the inflation target. this means that households and firms can rely on temporary deviations above or below this level being just temporary. one factor that could seriously undermine the credibility of the inflation target is if a higher rate of price increase led to large - scale demands for wage compensation. if wages and prices begin to chase one another upwards, as happened in the 1980s, everyone will lose out in the end. the importance of monetary policy for growth and vice versa the importance of monetary policy for growth is primarily connected to the need for stability in trade and industry and the labour market. when you businessmen and women have to make a decision on investment, you can now usually avoid having to worry that sudden fluctuations in the inflation rate will overturn your calculations. in most cases, temporary, minor deviations from the target should not change the final results of the calculations. the stability in planning that this creates should lead to more and better quality investments, which in turn should stimulate growth. this is reflected, for instance, in the fact that total factor productivity in the swedish economy increased strongly once macroeconomic stability was established in the 1990s. other countries around the world have had the same experience. macroeconomic stability promotes growth and productivity. what may be given less attention in the public debate is the importance of growth for our capacity to meet the inflation target - despite the fact that this really is a key issue. it is the demand in the economy in relation to production capacity that is the decisive factor as to whether inflationary bottlenecks arise or not. or, if we instead under - utilise production potential and therefore need to try to increase capacity utilisation. what determines whether there is a risk of overheating is the swedish economy's capacity utilisation in relation to its potential. i believe that one can say there is a type of inbuilt speed limit for the economy. it is difficult, as a rule, to know where this goes ; moreover it changes over time. external events, the dynamics in industry and in particular economic policy can change the potential growth rate of the economy. in other words, it is possible to both raise and lower the speed limit, depending on what is happening in the economy. however, at a given point in time there is a limit that cannot be exceeded or gone below without damaging consequences. if growth exceeds the limit for