countries'poor experience with a fixed, but adjustable, exchange rate regime. the first country to formally adopt a policy of targeting inflation was new zealand in 1990. canada did the same in 1991, followed by the united kingdom, sweden and australia. other industrial countries have also introduced some variant of inflation targeting since then, most recently two other nordic countries, namely norway and iceland. it is interesting to note that before the 1990s the predominant view was that a floating exchange rate regime is not suitable for a small open economy. today, i believe that experience has been exceptionally good among those countries that are explicitly targeting a low rate of inflation. in fact, some emerging market countries are now building the same kind of regime. in recent years countries such as south africa, brazil, the czech republic, poland and thailand have been inspired to introduce a similar strategy. consequently, explicit inflation targets have been introduced in quite a number of countries. the challenge during the 1990s for the inflation targeting countries has been to build a rigorous analytical framework around the new regime. questions such as the choice of rate and index to be targeted, the usefulness of tolerance intervals around the target and the degree of transparency in the monetary process all needed to be answered. it has also been important to formulate a monetary policy reaction function ; in particular, to define the balance between inflation variability and output variability. the reason why central banks do not aim for maximum short - term stability in either inflation or output is that attaining only one of the targets would be costly for the economy. on the one hand, the central bank's legitimacy among the general public could suffer if short - term interest rates have to move sharply, causing output to fluctuate widely while inflation is held stable and exactly on the target. maximum stability in output could, on the other hand, result in sharp fluctuations in the rate of inflation and erode the credibility of the monetary regime. a point somewhere midway between the two extremes must therefore be found. consequently we cannot be called " inflation nutters " as mervyn king, deputy governor of the bank of england, once said. let me also stress the importance of central bank independence. in order to be successful with the implementation of an inflation target approach, the central bank needs to be able to act independently of day - to - day party politics and to set interest rates continuously according to the specified inflation target. otherwise a credibility problem may arise because it would be hard for policymakers to convince the general public of monetary policy '

urban backstrom : monetary policy in a small open technology - oriented economy outside the major currency blocs speech by mr urban backstrom, governor of the sveriges riksbank and chairman of the board of directors and president of the bank for international settlements, at the conference on new challenges for credit markets and monetary policy, hosted by handelsbanken and held in stockholm, 18 may 2001. * * * thank you for inviting me to this conference and to discuss the swedish economy and monetary policy with such a distinguished group of people. today i intend to begin by looking back at economic developments in recent years in sweden. that should help to put the current discussion about the swedish economy in perspective. after that i shall be saying something about the economy's recent cyclical path and how i assess the future in the light of the information that is presently available. economic policy realignment in the early 1990s the direction of sweden's economic performance during the 1990s contrasts sharply with the unstable, inflationary path we experienced in the 1970s and'80s. that stop - go policy contributed to the recession in the early'90s, which was the worst for over sixty years. the 1970s and'80s illustrate how a long period of high and variable inflation creates an atmosphere of uncertainty and instability. slowly but surely, long - term conditions for production deteriorate. it was partly in the light of these experiences that swedish economic policy was realigned in the early 1990s. since then, the focus on price stability has gained broad support in our society. however, because of the severe economic problems in the early 1990s, with inflation expectations based on our historical record and a massive budget deficit, it took quite some time for the new direction of economic policy to acquire credibility. financial market developments can be regarded as an indicator of the prevailing degree of confidence in the determination and ability to conduct an economic policy that is consistent and oriented towards stability. with the free movement of capital and the globalisation of financial markets, economic policy decision - makers need to be highly disciplined. experience from other countries, where the policy realignment had already been made in the early 1980s, indicates that the creation of a low inflation regime's credibility takes time. but it also shows that after a while, such a process does ultimately yield a favourable economic development. the price stability target in the past decade a growing number of countries have chosen to conduct monetary policy with an explicit target for inflation. one reason behind this choice has no doubt been these