rate, but it takes a year until the greatest effects are attained for the twelve - monthly inflation figures. bis central bankers ’ speeches short - term inflation expectations are a component of the transmission mechanism that i feel are paid too little attention as a possible explanation for the low inflation. when firms set their prices, important factors are how they believe other companies will set their prices, and how they believe their customers will react to price changes. the same applies when employers and employees negotiate wages. if one believes that other companies will keep their prices and wages unchanged, it is more difficult to raise one ’ s own prices and wages. as inflation expectations appear closely linked to the most recent inflation outcomes, there is thus a risk that the low inflation becomes a self - fulfilling prophecy. one consequence of this type of reasoning is that it is important that monetary policy reacts early on when inflation begins to fall. the later one tries to deal with the problems, the more expansionary monetary policy will need to be to bring inflation up to the target. or to return to the rowing boat metaphor ; when one finds oneself in a very strong current, one needs to row very hard to get back. note that the two transmission channels i have focused on, the exchange rate channel and the expectations channel, do not necessarily have an effect through the real side of the economy. it is therefore fully possible that monetary policy has a substantial ability to influence the inflation rate even if real variables like unemployment and gdp growth are not so tangibly affected. based on this reasoning, my view is that monetary policy in sweden has good potential to bring inflation back to the target of two per cent. but i often come across arguments disputing this conclusion. let me conclude by giving my interpretation of these arguments and explaining why i am not convinced by them. misinterpreted : the impact of the repo rate on other interest rates has been weakened after the financial crisis the repo rate was cut by nearly five percentage points. but the interest rates households and companies could borrow at did not fall as much, as risk and liquidity premiums increased at the same time. however, these observations do not mean that the effects of changes in the repo rate have altered. a more reasonable interpretation is that the cuts in the repo rate have been counteracted by, and perhaps sometimes drowned bis central bankers ’ speeches in, other effects. 22 if the repo rate had not been cut as aggressively, households and companies would most probably have

martin floden : the low inflation – should we be worried and can we do anything about it? speech by mr martin floden, deputy governor of the sveriges riksbank, at saco ( the swedish confederation of professional associations ), stockholm, 14 may 2014. * * * thank you to bjorn andersson, charlotta edler, gabriela guibourg, kerstin hallsten, marianne sterner, christina nyman, stefan palmqvist, ulf soderstrom and other employees at the riksbank for valuable discussions and views on earlier versions of the text, and to andre reslow for help with data production. the views expressed in this speech are my own and are not necessarily shared by the other members of the executive board of the riksbank. those of you who follow the debate on monetary policy will probably not be surprised that the theme of my speech today is the low rate of inflation. this is the most important question for monetary policy right now. over the past year, i have emphasised the importance of ensuring that inflation does not get stuck far below the target of two per cent and said that monetary policy therefore needs to focus on avoiding such a situation. consequently, i entered a reservation against holding the riksbank ’ s policy rate unchanged at the most recent monetary policy meeting in early april. instead, i was in favour of a repo rate cut of 0. 25 percentage points. today i intend to focus on two issues. first, i wish to explain why i am worried by the low inflation rate. the reasons i will take up concern wage formation, the credibility of monetary policy, a too high real interest rate, and arbitrary reallocation from borrowers to lenders. i consider these to be serious problems. but at the same time i find some of the recent discussion on the problems with deflation – falling prices – to be exaggerated and focused on the wrong risks. second, i wish to discuss the ability of monetary policy to prevent inflation from falling too low. sweden is a small open economy and is affected to a great extent by international developments. this fact sometimes causes commentators to question rather resignedly whether the riksbank can actually influence inflation. i consider this attitude to be wrong. monetary policy determines how high average inflation will be. having said this, i am not claiming that we can control inflation with precision. monetary policy can prevent inflation from falling way below the target over a long period of time. it is