Structural factors can push inflation down in a way that can be difficult to counteract for a relatively long time, even if not permanently. It is therefore quite an important discussion that the Borio camp has initiated. 18 How should a central bank act in a situation in which, despite conducting the most expansionary policy it deems possible, it does not expect to be able to reach the target in a foreseeable time frame? As I see it, the reasonable decision in such a situation is to hold fast to the inflation target and continue with the expansionary policy. 19 If the central bank instead were to change its policy in a less expansionary direction, the inflation target would become even more distant and even more  17 Friedman (1963). It should be mentioned that, according to the so-called ‘fiscal theory of the price level’, fiscal policy has crucial influence over inflation, see for example Christiano and Fitzgerald (2000). To achieve low and stable inflation, a well-balanced monetary policy is therefore insufficient. It also requires fiscal policy to be conducted in a way that is compatible with the inflation target. However, this theory is controversial and does not actually question the value of central banks having inflation targets. 18 It should be emphasised that the BIS, where Borio is chief economist, has often been early to bring up issues of fundamental importance for central banks.
The growth of domestic demand is likely to be held back by the relatively tight fiscal policy as well as by the monetary policy tightening since May; and the effect this year of “windfalls” as a result of building societies’ demutualisations will be very much smaller. And we expect a deterioration in our net external trade position as a result of the strength of sterling’s exchange rate and now, too, as a result of the recent developments in Asia. The difficult questions for policy relate to the timing and the extent of the slowdown that is necessary on the one hand and likely on the other. These are difficult judgements at any time. They are particularly difficult when the economy is already close to full capacity. It is not surprising BIS Review 3/1998  -3-  that commentators differ in degree in their assessments. Economics is not - as I say - a precise science. Neither we at the Bank nor anyone else know with any great precision exactly where we are in relation to full capacity or exactly how fast capacity is growing; and we don’t know precisely either how demand will in fact respond to the policy tightening that is already in place. Our own best - and very carefully informed - guess is embodied in the forecasts that we publish each quarter, and we monitor immensely carefully the new information that becomes available day by day in the light of that forecast for early warning signs of emerging imbalance.