know exactly the speed at which the economy is actually growing. the statistics that we use when forecasting economic growth contain errors, do not provide a comprehensive picture of the economic situation and furthermore are produced with a lag. another problem is the difficulty in knowing exactly how long it takes before a rate adjustment has the desired effect. since it takes time – we allow for a time horizon of one to two years before the transmission mechanism has worked through the economic system – we have to form an opinion of the state of the economy in the long run. predicting the future is difficult for many reasons, not just due to statistical shortcomings but also because the economy is changing all the time. the economy can be hit by different kinds of shocks, e. g. the increased electricity prices when there was a shortage of water in sweden ’ s reservoirs, and the price of meat and other food when cows in europe were affected by a number of diseases. it is difficult to determine early on what changes in the economy are temporary and what are permanent. another factor complicating the picture is that inflation expectations in society greatly influence price and wage formation, and thereby inflation. in other words the car – to continue with the analogy – has a fogged windscreen, a speedometer that is very difficult to read and pedals that sometimes are sluggish and sometimes easy to push down. how can we make the economy go at an appropriate speed? in somewhat simplified terms there are two different ways to describe monetary policy based on inflation targeting : the first is to employ a simple monetary policy rule whereby the policy rate is set as a function of the current inflation rate and the output gap, which is a measure of the difference between actual and potential output and reflects resource utilisation in the economy. 1 when the output gap is negative, actual output is lower than potential output, which means that there are plenty of spare resources in the economy. in such a scenario price and wage increases are small and inflation is generally below target. when the output gap is positive the situation is the reverse : resources are overstretched and the excessive demand generates inflationary pressures in the economy. so according to the rule the policy rate should be raised if growth is above its potential rate and inflation is higher than the inflation target, and vice versa in the reverse situation. when actual and potential output are the same the economy is in balance and inflation is normally in line with the target, provided that policy is credible. a common argument

banks ’ costs which, to a certain extent, are passed on to customers in the form of an increased interest rate margin. this concept can be illustrated in the stylised equation for the lending rate by adding a variable ( ) which designates regulations affecting the interest rate margin : this equation is, of course, a simplification, but it is useful for illustrative purposes. it shows how some static macroprudential instruments, such as increased capital or reserve requirements, will affect the interest rate margin in a “ one - off shift ” when they are introduced, which will affect the transmission mechanism during the period of adjustment. however, there are also likely to be dynamic macroprudential instruments, such as time - varying countercyclical capital buffers, aimed at ensuring that macroprudential policy can influence the availability and pricing of credit throughout the cycle. these time - varying instruments will affect the transmission mechanism on an ongoing basis as they change over time. bis central bankers ’ speeches but the instruments are not perfect substitutes while the effects of monetary and macroprudential instruments may overlap, they are not perfect substitutes. 9 as stated earlier, the macroprudential policy toolkit is likely to include a diverse range of instruments that operate in different ways on different elements of the financial system. and the effect of these instruments on policy objectives other than macroprudential policy will also vary. for example, cross - sectional instruments are less likely to conflict with monetary policy than with the cyclical dimension of macroprudential policy. and instruments aimed at a narrow range of financial institutions or agents will be easier to focus on financial behaviour rather than macroeconomic factors. in general, it is desirable to use instruments with a narrower focus to address specific problems, as they can be better tailored to the problem and will have fewer unintended consequences on the real economy and on other policy objectives. however, there will be times when instruments with a broader scope will be desirable – for example, when there is a danger that developments in the financial system will enable agents to circumvent more narrowly focused instruments. the ability to circumvent instruments forms one of the challenges for macroprudential policy. the effectiveness of macroprudential policy could be strained when the build - up of risks ( for example, an asset price bubble ) in the financial system justifies significant policy intervention to contain the risks but the prevailing macroeconomic conditions do not justify a similarly aggressive monetary policy