to absorb temporary deviations from trend inflation. such deviations may arise, for instance, from political decisions to alter indirect taxes and subsidies, changes in interest rates as well as from international price shocks. for march 1997 the consumer price index showed a twelve - month fall of 0. 4 per cent. however, this figure was to a large extent influenced by last year ’ s sharp repo rate cuts. when home owners renew mortgage loans at lower interest rates we get a transitory downward effect on inflation. it is important to distinguish between cpi changes and underlying inflation. transitory effects, for example changes in interest rates or in indirect taxes and subsidies, may cause the general price level to jump up and down. in the conduct of monetary policy it is therefore important to keep an eye on underlying inflation ; the transitory effects are of secondary significance as long as they do not affect inflation expectations and thereby trend inflation. given the time lag that applies to monetary policy, a central bank that targets inflation has to monitor the various factors which determine inflation one to two years ahead. in a simple analysis of inflation ’ s determinants one can start from the familiar augmented phillips curve. the rate of inflation is determined by two factors : the relationship between supply and demand in the economy - the output gap - and inflation ’ s expected rate. note, however, that while the output gap is a useful starting point for an inflation analysis, there is no simple way of measuring it. this makes it necessary to go into more detail and study a variety of indicators in order to analyse any tensions between demand and supply. still, the output gap is a suitable starting point for my present purpose. the simple model tells us that when the output gap is closed, inflation is constant and equal to the expected rate. this means that, with normal capacity utilisation and given a low level of inflation expectations, actual gdp can follow potential output. in such a situation some form of external shock is needed to shift inflation upwards or downwards. this can mean either that production falls below or rises above the level for normal capacity utilisation or that inflation expectations move up or down. the latter case is ultimately a matter of confidence in economic policy ’ s consistency and its future reactions. the ability of monetary policy to influence inflation has to do with the impact of the instrumental rate on the path of gdp and thereby on the degree of capacity utilisation, together with its effect on inflation expectations. in practice a period of restricted demand

ea eall s a v i n g - 4 - 6 - 8 s o u r ce cess : s t a t i s t i c s s w e d e n a n d n a t i o n a l i n s t i t u t e o f e c o n o m i c r e s ea earr c h a number of structural reforms ( cuts in transfer systems, the tax reform, etc. ) have probably elicited a permanent increase in the household saving ratio but the future tendency is difficult to foresee. one approach is to compare with countries where the economic framework for households resembles that in sweden. this suggests that both the household net saving ratio and the ratio of total wealth to disposable income are relatively low in sweden. it then seems unlikely that in a long - term perspective the saving ratio will fall back to the historically low levels in the 1980s ( diagram 5 ). leading indicators point to a continuation of private consumption ’ s upward tendency in the first quarter of 1997. house prices have shown signs of moving in recent months. a growing money supply and lending to the household sector likewise point to a continued increase in consumption. retail turnover, above all for consumer durables, strengthened in february and march, as is also evident in the march business tendency survey from the national institute. in the first four months of this year the number of cars newly registered in the household sector rose in annual terms by around 60 per cent. households have become more optimistic about their own economy ; in april a majority envisaged an improvement 12 months ahead. there is no cause at present to modify the main assessment in the inflation report - that consumption will show a stable but by no means dramatic rise in the coming years. but an appreciably weaker development of consumption, which was a prominent component of one of the alternative scenarios, seems to have become somewhat less probable. exchange rate the riksbank does not target the exchange rate. the monetary policy target is price stability. but the exchange rate does feature as one important factor in the riksbank ’ s assessment of inflation in the coming two years. the exchange rate conditions demand in the economy, particularly in the export sector, and also affects inflation directly in the form of import prices. the latter, more immediate effect is, however, transitory and of secondary interest provided it does not influence inflation expectations and thereby price and wage setting behaviour. an assessment of future inflation therefore