History of the inflation target
In the early 1990s, Sweden was in the midst of a deep economic crisis. 19th November 1992 will always have a special significance for the Riksbank. This was the day when, under very dramatic circumstances and after a stubborn defence of the Swedish krona, it was forced to abandon the fixed exchange rate against the ECU, the predecessor of the euro.
A floating exchange rate was adopted leading to a rapid depreciation in the value of the krona. Since then, Sweden has maintained a floating exchange rate, which means that the value of the krona against other currencies is allowed to fluctuate. In connection with the adoption of a floating exchange rate, a new monetary policy was also established, in which price stability was to be achieved via a direct target for inflation.
The origin of the inflation target
In January 1993, the Riksbank announced that price stability was still the overall objective of monetary policy, despite the move to a floating exchange rate, and quantified it as a two-percent inflation target, measured as an increase in the consumer price index (CPI), with a tolerance level of +/- 1 percentage point. The idea of the tolerance interval was to make it clear that deviations from the inflation target were probable, and that the Riksbank's aim was to try to limit these deviations. The inflation target would formally begin to apply from 1st January 1995. Over the two years leading up to 1995, monetary policy was to be aimed at preventing the underlying rate of inflation , which had decreased to a level around two per cent, from increasing again. When the fixed exchange rate was abandoned, the value of the krona against other currencies had weakened substantially and there was a risk of it, together with other factors, pushing up inflation.
In this way, a new norm for monetary policy was created and Sweden thus became one of the first countries in the world to conduct monetary policy with a floating exchange rate and a specific inflation target. It now became important to create credibility in the new policy and to quickly build up confidence in the inflation target.