rate path is a forecast not a promise per cent, quarterly average 90 % 75 % 50 % repo rate mar - 03 m ar - 04 mar - 05 mar - 06 mar - 07 m ar - 08 mar - 09 mar - 10 mar - 11 source : the riksbank what can monetary policy accomplish? low and stable inflation cannot affect employment and production in the long term … … except through providing conditions for a good and sustainable economic development. in retrospect … not as easy as one might think monetary policy must be based on forecasts much will happen between the forecast and the final outcome uncertain data? monetary policy considerations? unpredictable events? poor forecasting? what demands can one make? on average, not poorer accuracy consistency between different variables the driving forces should be explainable other reasons for deviations normally we try to reach the target within 2 years may deviate deliberately considerations for the real economy must be communicated clearly so how did it turn out? cpi and cpi - forecasts annual percentage change 3. 5 3. 5 cpi 3. 0 3. 0 forecasts 2. 5 2. 5 2. 0 2. 0 1. 5 1. 5 1. 0 1. 0 0. 5 0. 5 0. 0 0. 0 - 0. 5 - 0. 5 sources : statistics sweden and the riksbank

last upswing and from capturing the impact of tightening credit conditions in the downswing. i should emphasise that the mpc is not a slave to any one model. the current governor reminds us frequently that : “ it is vital never to confuse the world with a model. the whole point of a model is to abstract from a wider range of factors in order to think clearly about one particular issue. ” 4 over the last couple of years, for example, we have drawn on a range of models to capture the impact of credit markets. the mpc bases its forecasts on all the evidence. and most forecasts have a lot of added judgement in them. but our main macro model sets a baseline for our discussions and forces us to quantify and integrate different judgements. it is difficult to see how the committee could reach a consensus on a forecast ( albeit with a probability distribution around the central projection ) without a model of some sort. all models are simplifications and all models have difficulty identifying turning points. but we badly need some new thinking to make them better. putting banks into the models would be a good place to start. the model of the banking sector which is being developed in the financial stability wing of the bank will make a good contribution to that. lesson 5 : mopping up after the bust is not a good strategy the world ’ s central banks have tended to follow similar strategies. so much so that an american economist, john taylor, was able to neatly summarise how monetary policy is set with a very simple rule. he found that movements in interest rates around their long - run level could be explained by just the level of inflation relative to its target, and imbalances between the level of demand in the economy and the capacity of the economy to produce output. http : / / www. kc. frb. org / publicat / sympos / 2005 / pdf / king2005. pdf. asset prices and stock imbalances of the kind we have seen on the balance sheets of banks, households and companies are conspicuous by their absence in the taylor rule. whether policymakers actually slavishly follow the taylor rule, or it simply represents a good description of how we behave is largely immaterial. either way, the default position of policymakers has been that interest rates should not be used to choke off a boom in financial markets. that non - interventionist doctrine was based on two key judgements. first, that the costs