one of the driving forces behind these capital flows is assumed to be the policy conducted in large, leading countries. these flows can make it difficult to conduct monetary policy in other, smaller countries and may have consequences for the macroeconomic and financial stability there. trilemma or dilemma? to be rather more concrete, let me proceed from what is known, in international macroeconomics, as the “ trilemma ” ( see figure 2 ). the idea is that countries are assumed to strive for three circumstances that are usually all desirable : free movement of capital, monetary policy autonomy and a stable exchange rate. the problem is that all three cannot be attained simultaneously. if you want to conduct a monetary policy of your own and, at the same time, have a stable exchange rate, the movement of capital must be regulated. without regulation, a country would find it difficult to conduct a monetary policy resulting in an interest rate deviating substantially from those of other countries. differences in return would lead to large currency flows that would exert pressure on the exchange rate. if you want to allow free movement of capital but still have a fixed exchange rate, you cannot conduct a monetary policy of your own. this was the case in sweden before we transitioned to a floating exchange rate : monetary policy was aimed at ensuring that currency flows were balanced so that the desired krona exchange rate was not exposed to pressure. finally, having free movement of capital and your own monetary policy, like sweden does today, requires a floating exchange rate. bis central bankers ’ speeches figure 2 the trilemma in international economics fixed exchange rate free capital movement autonomous monetary policy some argue that, in light of the present large international capital flows and globalised financial markets, not even a floating exchange rate can always sufficiently guarantee that a country will be able to conduct its own monetary policy, or at least that the capital flows make such a policy considerably more complicated. one hypothesis that has gained attention is that the capital flows can be regarded as part of a global financial cycle. this cycle also consists of asset prices and credit growth and it covaries with measures of uncertainty and risk aversion on the financial markets. 3 it also appears that the most important driving force behind the cycle is the monetary policy conducted in large countries, particularly the united states. free capital movement makes it more difficult to isolate a country from the rest of the world – and indirectly thereby from monetary policy in large countries – even if it has a floating exchange rate. some go so

of events has to be prevented by the riksbank, which the riksdag ( sweden ’ s parliament ) has made accountable for maintaining price stability. so sooner or later the level of the repo rate will have to be normalised in order to counter an acceleration of inflation in an upward cyclical phase. this is something that the riksbank is discussing, as was evident from the published minute of the executive board meeting on 12 august. in the present circumstances what we have to do is decide when – not whether – the time has come to initiate the shift towards a less expansionary monetary stance. as regards the timing of this type of monetary policy measure, it is generally true to say that if the riksbank waits too long before making a necessary repo rate adjustment, when the increase does come it may have to be larger than otherwise in order to arrest the overheating and inflationary tendencies. that could introduce undue instability into output and employment. a higher repo rate does not necessarily impede the continuation of a favourable economic trend ; it may even be required for a good and sustained development of employment and growth, as is illustrated by how the federal reserve has acted in the united states. a judicious series of increases in the federal funds rate seems to have contributed to the longest post - war period of growth in the united states. since it was raised by degrees from 3 % from 1994 to 1995, the american instrumental rate has moved between 4. 5 and 6 %. having said this, it must be realised that there is no simple answer to the question of what constitutes a judicious timing or magnitude of a repo rate increase. one alternative, of course, is to act early and make a small increase even though indications of growing inflationary pressure have not actually shown up. such a line can be seen as insuring against the adverse consequences an acceleration of inflation might entail. in my opinion, however, there are other aspects that it is important to analyse and incorporate in the assessment. lower inflation propensity? one reason for greater circumspection today in monetary policy is that the trade - off between growth and inflation may have changed. during the 1990s the paths of inflation and real economic activity in many countries, sweden included, have not followed the pattern that their earlier relationship suggests. this has started a discussion, in the united states and elsewhere, of whether macroeconomic structures have changed so that higher growth is now feasible without