To make matters worse: because everyone was used to inflation around 6%, indexation had set in – prices and wages across the economy were locked in to grow at this pace. This left us in a trap: nominal interest rates had to be high because inflation expectations were anchored at around 6% but high interest rates meant there was always pressure to cut.
Meanwhile, the indexation bias meant that inflation never fell much, and so in turn interest rates stayed structurally high. The paradox is that we have often been accused of being hawkish and keeping interest rates too high, when in reality we have often tolerated as much inflation as we can, ignoring the bottom half of our target range.