We do this by acting in a symmetrical manner; that is, we pay equal attention to any significant movement in inflation away from the 2 per cent target, whether above or below. The crucial task in controlling inflation is to judge how the economy is performing relative to its economic potential.
Economic potential is a very important concept, so I want to take a minute to describe it. Potential output, or production capacity, is the amount of goods and services that can be produced without putting pressure – in either direction – on inflation. When the economy is producing less than its potential, economists say there is an output gap.