Ingves: Inflation-targeting policy requires updates to meet future challenges

The inflation targeting policy has been resilient and adaptable – both in normal times and in times of crisis – for almost 30 years. However, for inflation targeting to be able to manage the various crises that may arise in the future, it needs to be updated in line with the changing world around us. Some macroprudential tools should lie with the Riksbank and, in addition to price stability, financial stability should be given a certain weight in monetary policy decisions, as Riksbank Governor Stefan Ingves said today when he gave his annual speech at the Swedish Economic Association.

Date: 31/05/2022 12:00

Speaker: Governor Stefan Ingves

Place: Swedish Economics Association

A well-functioning payment system, stable government finances and an effective monetary policy toolbox are essential prerequisites for the functioning of the inflation targeting policy. Inflation and long-term inflation expectations have on average been close to the target of 2 per cent since the introduction of the inflation target, and this has contributed to the Swedish economy having managed two economic crises of different kinds relatively well. However, Stefan Ingves sees the rising inflation as a challenge going forward:

"The inflation target has never been tested in a high-inflation environment. The experiences of the 1970s showed that it can be very costly to bring down inflation once it has become established at high levels. Another lesson is that monetary policy cannot be passive once inflation has begun to rise. Monetary policy needs to be proactive and focus on counteracting price increases to avoid losing credibility.”

Stefan Ingves also pointed out that climate change could be another challenge for the inflation targeting policy going forward. He said that central banks need to improve their analyses and understanding of the economic effects of climate change, and how they affect the conditions for monetary policy objectives.

The years of inflation targeting have taught us a number of things. For example, it was very costly to 'clean up' after the financial crisis and the recession lasted a long time. Moreover, the financial system has grown and the imperfections in the financial markets have increased in significance. Financial stability and monetary policy have therefore become increasingly interlinked. Financial stability is a necessary requirement for price stability. Given this, the monetary policy framework needs to be modified, according to Stefan Ingves.

“Some of the macroprudential tools, such as the countercyclical capital buffer, should lie with the Riksbank. Additionally, financial stability should carry a certain weight in monetary policy decisions. With these updates, I would not be surprised if inflation targeting is monetary policy’s 'killer app' for the next 30 years, too.”

Updated 31/05/2022