target was not self - evident. real price stability could be perceived as the inflation rate being zero per cent, but neither we nor any other country has chosen such a target. one argument is that it is good to have some margin as there is a risk that cpi overestimates inflation. for instance, it is difficult to exactly measure price increases as a result of better quality, which is thus not inflation. another argument is that it is often difficult in practice to implement nominal reductions in prices and particularly wages. some measure of inflation may therefore simplify necessary adjustments in relative wages and prices. at the same time, there have seldom or never been attempts to stabilise inflation at a level much higher than 2 per cent. this may be because this does not sufficiently anchor inflation expectations. experiences from sweden and other countries indicate that low, stable inflation is an important condition for favourable economic growth and that the work on maintaining low, stable inflation is made easier if the central bank can act independently. this is why the riksbank, like many other central banks, has been given greater independence and an inflation target. if the central bank is not allowed to independently formulate monetary policy there may be political pressure to conduct monetary policy that aims to achieve other objectives. how does the riksbank influence inflation? the tool the riksbank has at its disposal for steering inflation is the repo rate. this is the interest rate the banks pay to borrow money from us. the objective of changes in the repo rate is to influence demand in the economy and thereby price developments. when the riksbank alters the repo rate, there is an effect on total demand and ultimately also inflation through various channels within the economy. these channels are the cost of borrowing, incentives to save and wealth, as well as exchange rate fluctuations that affect imported inflation, exports, imports and capital flows. in addition, there is an effect on inflation expectations. it takes some time for an interest rate change to have an effect through these channels. the monetary policy decisions must therefore be based on an assessment of future inflation. flexibility thanks to credibility conducting monetary policy is not the same as flying a familiar, well - tuned aircraft. the repo rate is unfortunately a blunt instrument with regard to steering inflation, even a couple of years ahead. what monetary policy can do is to ensure an inflation rate that is over a number of years in line with the target and to contribute to reducing fluctuations in the real and financial economy. when

regulating hlis themselves. 14 a realistic assessment of the systemic importance and the disruptive capacity of hlis leads us to the conclusion that direct prudential regulation would be difficult to justify. there is no market failure which needs to be addressed through regulatory measures. thus the apparent benefits to be delivered by regulation appear not to justify the related costs, such as reduced market efficiency and slower financial innovation. furthermore, the hli industry is very heterogeneous and many funds are registered in exotic off - shore locations and, hence, beyond the jurisdiction of the main regulators. therefore, we doubt that direct regulation is feasible and superior to market discipline or to a best practice approach. 5. conclusions the hli industry has become increasingly important in recent years. in some market segments, especially in more complex ones, a large share of trading volume is attributed to hlis. however, measured by assets under management, the hli industry is still small compared to traditional investment funds and the trading books of large international banks. because of its modest size, its see also the president's working group on financial markets, 2007, recommendation 5. heterogeneity and its absence from the field of financial intermediation, the hli industry is no direct threat to financial stability. nevertheless, there are two channels through which a shock occuring in the hli industry could be transmitted to systemically relevant banks. first, banks are exposed to hlis in their role as counterparties and creditors. second, in periods of stress, banks may suffer from a lack of market liquidity and a decline in prices, and this may be aggravated by hlis. potential regulatory measures should therefore focus on the link between the hli and the banking industry. of particular importance is that banks simulate their risk exposures to hlis and the liquidity situation in periods of stress. we encourage the private sector to take the initiative and come up with measures which will enhance market discipline and strengthen banks'resilience to losses from hlis and adverse market situations. at present, we do not see a need for direct regulation of hlis. however, central banks and regulatory authorities will closely follow developments in the hli industry, in particular the initiatives taken by market participants to mitigate spillovers to the banking industry. references counterparty risk management policy group ( 2005 ), " toward greater financial stability : a private sector perspective, " the report of the counterparty risk management policy group ii. de nederlandsche bank (