4 Inflation ForecastTargeting: The Swedish Experience

An inflation target can serve as a nominal anchor, aiming at coordinating in-flation expectations. As a nominal anchor, an inflation target also provides a commitment mechanism that increases the accountability of the monetary policy authority. The inflation target communicates to the public the inflation rate at which the central bank will aim in the future. It thus serves as a refer-ence point against which the central bank can be judged. In January 1993 the Sveriges Riksbank, the central bank of Sweden, specified that the objective of monetary policy would henceforth be to limit the annual in-crease in the headline consumer price index (CPI) in 1995 and beyond to 2 per-cent, with a tolerance of plus or minus 1 percentage point. This objective corre-sponded to the so-called underlying rate of inflation when the target was announced. In 1993 and in 1994 as well, monetary policy aimed at preventing the inflationary impulse (which was deemed unavoidable) due to a large deprecia-tion of the krona and changes in indirect taxes from causing a persistent increase in the underlying rate of inflation. The experience of the first years of inflation targeting in connection with the most recent amendments to the 1988 Riksbank Act, which came into force on January 1, 1999, and prescribe an explicit objective for monetary policy, gave reasons to clarify the formulation of monetary policy. Maintaining Price Stability The principles on which monetary policy decisions in Sweden are based can be formulated as a simple rule of thumb.2 If the inflation forecast, based on a