and the krona suddenly weakened, we consider that countervailing forces would act in financial markets. the value of a currency is determined by numerous factors, of which the most important is confidence in the country ’ s economic policy. the general trend towards internationalisation in recent years has entailed relatively large currency outflows due to portfolio diversification among resident investors. but at the same time the krona has displayed an appreciating trend as growing confidence in economic policy generated a compensatory currency inflow. all in all, conditions for a stable exchange rate between the krona and the single currency should be good. there are many indications that the european central bank will define a price stability target that resembles sweden ’ s. similar inflation trends, together with confidence in economic policy as a whole, should result not only in stable nominal and real exchange rates between the euro and the krona but also in conditions for a reasonable valuation of the krona. monetary policy ’ s current construction a long target horizon permits a gradual monetary adjustment when assessing monetary policy ’ s construction, we look ahead to assess the path of inflation in the coming twelve to twenty - four months. a relatively long target horizon does have the drawback that earlier assessments may have to be revised. one reason for choosing a long horizon - with the attendant difficulties in making reliable forecasts - is the time lag before effects of monetary policy materialise. by acting in good time, it is possible to adjust interest [UNK] policy more gradually and smoothly. in this way, any consequences that altered inflation prospects may have for the monetary stance will usually be gradual and small. with a shorter target horizon, the inflation assessments might be more accurate but the monetary policy responses would have to be more pronounced in order to fulfil the target. there would also be wider fluctuations in output and employment. real factors like production and employment are accordingly taken into account when making this choice. in view of the difficulties in assessing and forecasting economic tendencies and monetary policy effects exactly, the riksbank has opted for one to two years as its normal target horizon. lower cpi figures the forecasting problem can be illustrated with assessments from the national institute of economic research ; i use them here simply as an example, not to single out the national institute from other forecasters. but the national institute is one of the forecasters with the largest resources and it usually “ sets the trend ” for other forecasters. last november the institute counted on annual rates of

, is the underlying trend. in that this trend is in line with the target, conditions are created for sustainable growth. in the event of a demand shock there is thus no conflict between combating inflation and promoting growth. transient price effects of secondary importance besides effects from demand shocks, price movements are influenced by disturbances in supply. supply - side shocks vary both in kind and in the duration of their effects on the economy. the monetary policy response accordingly depends on how suddenly such a shock occurs and how soon it fades. a supply shock with a direct effect on prices, for example a vat increase, should be distinguished from an increase in productivity, which affects demand via resource utilisation. let me start with the former case. a vat increase will tend to subdue demand at the same time as it adds to the 12 - month rate of cpi inflation over a period of one year. in this case, in the first year after the tax increase, demand and inflation move in opposite directions. if the monetary stance were to be tightened in order to achieve a prompt return to inflation ’ s targeted rate, it would cause demand to fall further. temporary price stabilisation would be accompanied by a destablisation of real economic activity. a similar dilemma is posed by vat reduction, which stimulates the economy and lowers registered inflation. a monetary policy response in the form of a repo rate cut - to return inflation to the target - would act as a further economic stimulus. here, too, temporary price stabilisation would be accompanied by a destablisation of real economic activity. i have used vat adjustments here as an example of shocks from the supply side. effects of the same type are associated with changes in other indirect taxes, for instance the current proposal to lower the tax on tobacco. the same applies to international oil price movements, as well as to the riksbank ’ s own interest rate adjustments, which have a direct impact on house mortgage interest costs. how, then, should monetary policy deal with a situation in which prices are exposed to supply shocks of this kind? part of the answer lies in the circumstance that - provided people ’ s medium or long - term inflation expectations remain unaffected - most shocks of this type are transitory. the riksbank has concluded that in the normal course of events, transitory price effects of this type ought to be a secondary consideration in the construction of monetary policy in so far as they do not affect inflation expectations and thereby