some time before the inflation target is attained, the riksbank can contribute to stabilising the development of the real economy, but at the same time we must safeguard confidence in the inflation target. taking into consideration developments in the real economy must not mean that the price stability target is set aside. the two - year horizon provides scope for flexibility but at the same time sets a limit for how large the deviations from target can normally be. the fact that we have chosen to specify an exact target for inflation is an expression of our desire to be clear and open. this is also why we have explicitly stated that inflation will normally be returned to target within two years. similarly, the deviation interval around the inflation target aims to explain that monetary policy cannot, and does not, attempt to exactly attain the target all of the time. the deviation interval thus also emphasises that there must be scope for temporary deviations from the target, which may be justified with regard to avoid unnecessary fluctuations in growth and employment. we thus endeavour to attain the inflation target within a two - year time perspective, under normal circumstances. in certain cases, however, we may need to have even greater flexibility than the twoyear perspective allows. if the economy were to suffer very large supply shocks, for instance, in the form of structural changes that have a major effect on inflation, or if extreme situations such as war or natural disasters occur, the process of bringing inflation back to the target may need to take even longer to avoid excessive strain on the real economy. in this type of situation it would be even more important that there was confidence in the inflation target. however, flexibility must not be allowed to undermine the nominal anchor. if confidence were to fail, we would be forced to act more strongly and would not have the same possibility to consider the real economy. thus, the objective of monetary policy is to maintain price stability. however, it is possible to give consideration to the development of the real economy. this does not mean having a target for growth or employment. instead, this type of consideration is made possible by the way in which we have chosen to formulate the principles for attaining the inflation target. however, it assumes that there is sufficient confidence in the inflation - targeting policy. changes in our analytical framework as monetary policy has an effect after a time lag, the riksbank must look ahead and base its interest rate decisions on forecasts of future developments, for instance, regarding economic activity and inflation. like other central

ltcm ’ s investors, creditors, or managers from loss, but to avoid the distortions to market processes caused by a fire - sale liquidation and the consequent spreading of those distortions through contagion. to be sure, this may well work to reduce the ultimate losses to the original owners of ltcm, but that was a by - product, perhaps unfortunate, of the process. i should add that, in order to keep incentives working in their favor, the creditors of ltcm apparently also understood the importance of some cushioning of the losses to the owners and managers of the firm. the private creditors and counterparties in the rescue package chose to preserve a sliver of equity for the original owners - one tenth - so that some of the management would have an incentive to stay with the firm to assist in the liquidation of the portfolio. regrettably, the creditors felt that, given the complexity of market bets woven into a bewildering array of financial contracts, working with the existing management would be far easier than starting from scratch. some questions for policy makers without doubt, extensive study will be required to put the events of the past few weeks into proper perspective. as a member of the president ’ s working group on financial markets, i support secretary rubin ’ s call for a special study on the public policy implications of hedge funds. while the affairs of ltcm are by no means settled, i would like to pose some tentative questions that may have to be addressed. first, how much dependence should be placed on financial modelling, which, for all its sophistication, can get too far ahead of human judgement? this decade is strewn with examples of bright people who thought they had built a better mousetrap that could consistently extract an abnormal return from financial markets. some succeed for a time. but while there may occasionally be misconfigurations among market prices that allow abnormal returns, they do not persist. indeed, efforts to take advantage of such misalignments force prices into better alignment and are soon emulated by competitors, further narrowing, or eliminating, any gaps. no matter how skilful the trading scheme, over the long haul, abnormal returns are sustained only through abnormal exposure to risk. second, what steps could counterparties have taken to ensure that they had properly estimated their exposure, particularly in markets that are volatile? to an important degree, the creditors of ltcm were induced to infuse capital into the firm because they failed to