the mechanisms operate that permit the central bank to determine the value of money – what is known as the transmission mechanism. for the most part, however, there is little knowledge of these very complicated mechanisms. the rapid development in the financial markets means moreover that the conditions for monetary policy are continually changing. it is therefore natural for the rules of action and strategies that govern monetary policy to be discussed and evaluated. i am going to begin by giving a short review of how the transmission mechanism is usually described and to discuss the changes that have taken place. against this background, i will then briefly describe how the riksbank conducts its monetary policy. what is the role of money? the quantity theory describes in a simple way how inflation is determined. in this theory, the price level is determined by the quantity of money in the economy. production is determined over a somewhat longer period by access to labour and by the development of productivity ; monetary policy does not affect production in the long term. it is intuitively easy to understand that at a given level of production the price level will increase if the quantity of money increases and vice versa if the quantity of money decreases. in an economy where only banknotes and coins serve as means of payment, the central bank can control inflation by determining the quantity of banknotes. this is conditional on the central bank knowing how much is required at a given price level in order for a particular quantity of goods to be produced and circulated - the speed or velocity of circulation must be known in order for a money quantity target to be used to control price movements. developments in the financial markets in general and of the payment system in particular have, however, led to a reduction in the importance of banknotes and coins as a means of payment, i. e. money. an increasing proportion of payment flows takes place by transfers between accounts and the ability of the central bank to influence the quantity of money in the economy is largely only through its ability to affect the demand for money by the general public. the quantity of money required by the general public depends on its demand for transaction funds for the purchase of goods, services and financial assets, which in turn is affected by the interest rates encountered by the general public. for instance, lower interest rates increase demand for money when businesses'demand for capital goods and households'demand for consumption increases. thus, demand for goods and services are both sensitive to interest rates and largely reflect one another. by controlling the interest rate, the central bank thus affects both the

these convexity effects are normally limited, but will grow if uncertainty about the future increases. bis central bankers ’ speeches expectations provide such a mixed picture, it is not surprising that different analysts reach different conclusions. figure 1 two - year forward interest rates and money market agents ’ repo - rate expectations two years ahead according to prospera per cent sources : reuters ecowin and tns sifo prospera. note. forward rates have been adjusted for risk premiums and describe the expected overnight rate. risk premiums include both credit risk and maturity premiums. the dates of prospera ’ s surveys refer to the dates the surveys were carried out. so, how should you go about assessing market expectations in such a situation? this is a difficult question and i have no complete answer. however, this should not stop us from trying to determine how to evaluate different measures of monetary policy expectations. let me begin with forward rates. forward rates have many merits. they reflect market expectations for many different time horizons and they can be observed continuously, which makes it possible to analyse how market expectations are affected by different events. often, but not always, they also provide a fairly reasonable picture of market expectations. however, the problem with forward rates, as we have already seen, is that they are also affected by a range of other factors and this sometimes means that they provide a misleading picture of market expectations. the performance of swedish two - year forward rates since the early summer illustrates this, see figure 1. we can see that two - year forward rates, adjusted for a risk premium 3, at the beginning of the summer were at approximately the same level as the money market agents ’ two - year reporate expectations according to prospera. subsequently, however, there was a clear downward trend and from early june to mid - september the two - year forward rate fell by approximately 80 basis points. in my opinion, a substantial downward shift in monetary policy the forward rates in figure 1 are adjusted using a constant risk premium of approximately 25 basis points, which is a rough estimate of the average size of the risk premium for this time to maturity. bis central bankers ’ speeches expectations in this period was hardly realistic given the fact that the swedish economy was, at the same time, surprisingly strong. later, during the autumn, two - year forward rates increased and were roughly half a percentage point below the expectations in the surveys. an interpretation that i find more likely is that the development of forward rates in