Because monetary policy operates with long lags, price stability is typically defined over the medium term, giving central banks some discretion over the extent and length of inflation overshoots that they are willing to tolerate over the short run. This discretion is particularly relevant in the case of supply-side shocks that tend to push prices and output in opposite directions.
Stabilising inflation is then no longer equivalent to stabilising output – the divine coincidence of monetary policy disappears. [15] Such shocks therefore imply a trade-off for monetary policy, between inflation and output. The experience of the 1970s suggests that the extent of this trade-off is highly path dependent.