are one of several signs that imbalances are building up in the economy. there is cause to be observant when notable increases in asset prices are accompanied by strong credit growth, rapidly rising investment, a market deterioration of the private sector ’ s financial balance and growing deficits on the current account. as mentioned earlier, such a situation does not necessarily mean that the rate of inflation rises immediately. if the central bank does not act to limit imbalances and excesses of this type, the result may accordingly be serious adjustment problems in both the financial system and the real economy, with a risk of subsequent deflationary tendencies. this means that an unduly rigid interpretation of the riksbank ’ s rule of action in monetary policy is associated with risks. i do not find it difficult to envisage a situation where the rule of action and the inflation target must defer to a tighter monetary stance. my view of how monetary policy ought to react to asset prices is connected with my experiences as under - secretary at the finance ministry during the banking crisis in the early 1990s. if rising asset prices are a symptom of a wider build - up of imbalances in the economy, then monetary policy must aim to limit the risks of bubbles blowing up in the financial sector and the real economy. that is not meant to imply that determining when such a situation is on the way is particularly easy. the " flexible inflation targeting policy " the riksbank has defined also allows temporary departures from the simple rule of action. in my opinion there is support for this in the law and its prefatory documents. however, if a situation were to arise that might justify a departure from the current rule of action, it is important to be particularly explicit about what monetary policy is guided by. besides enabling the general public and market investors to know how and why the riksbank acts as it does in such a situation, this makes it possible to exercise democratic control even when the target of 2 per cent inflation has to take second place. an influential paper that summarises the traditional view of how monetary policy ought to address asset prices is bernanke, b. & gertler, m. ( 1999 ), " monetary policy and asset price volatility ", in new challanges for monetary policy, proceedings of the symposium sponsored by the federal reserve bank of kansas city, jackson hole, wyoming, pp. 77 - 128. an alternative opinion is presented in cecc

this may lead to inflation being below the target more permanently, which in turn ought to lead, according to the rule of action, to a downward adjustment of the instrumental rate. the stimulus from monetary policy acts through the usual channels. so all else equal, one can expect a fall in market interest rates, rising share prices, a stronger expansion of credit and so on. general demand rises, employment moves up, unemployment falls and the inflation target is fulfilled. when the price effects have waned, there is a risk, if nothing else intervenes, of inflation rising above the target. to counter this, monetary policy responds by gradually increasing the instrumental rate again. market interest rates move up, share prices fall and the growth of credit slackens. in other words, the customary transmission mechanism now works in the opposite direction, leading to some fall in production and employment as well as in resource utilisation. another component of the process is the higher inflation ’ s limiting effect on household real income, just as the lower inflation benefited household income. inflation then falls back to the targeted rate. for clarity ’ s sake i should perhaps add that this reasoning presupposes that inflation expectations are not affected. the exchange rate ’ s reactions to monetary policy measures are not entirely given. text books say that the exchange rate weakens in a scenario with monetary stimuli and appreciates when the instrumental rate is increased. that should normally be the case as long as nothing else happens. but the fact remains that there have been many instances all over the world of exchange rates appreciating even though instrumental rates have been cut and vice versa. in such situations market players have often attached greater weight to the prospects of faster or slower economic growth — provided the rate of inflation is expected to remain low. so it is not entirely clear how the exchange rate will ultimately be affected when the intrumental rate is raised or lowered. were it the case that regulatory changes always refer to a particular group of goods or services, one might consider excluding this group from the price index that monetary policy aims to stabilise. a disadvantage of this might be that monetary policy would be guided by an indicator of inflation that is not the most relevant one for consumers. on the other hand, it could confer the advantage of making monetary policy simpler and more predictable. in practice, however, adjusting the consumer price index for shocks of this type is virtually impossible. the effects can come from a series of deregulations that affect different stages