Chart 3 shows that the slope of the short-run Phillips curve has moved around during the post-war period, apparently in response to changes in the monetary policy regime. In the 1970s labour market pressure was not offset by tighter monetary policy, leading to a spiral of wage and price inflation. The short-run Phillips curve steepened, with larger inflationary consequences of any deviation from the natural rate of unemployment. As monetary policy became more focused on controlling inflation, the Phillips curve flattened in the latter part of the 1980s and 1990s. Such changes in the monetary policy regime can also be detected in the behaviour of inflation over time. Table 2 shows that the persistence of inflation – measured by the estimated explanatory power of past inflation in predicting current inflation – has fallen quite markedly since the inflation target was introduced in 1992. Was this  4  BIS Review 36/2005  because the failure of monetary policy to react quickly to an inflationary shock in the 1970s meant that inflation remained high for some time? And has the prompt response of monetary policy meant that movements in inflation more recently have proved short-lived? The answers to these questions matter for monetary policy. But the economy is continually evolving, and we can never definitively conclude that one answer is right and the others wrong. So learning about changes in the structure of the economy lies at the heart of the daily work of central banks.
Because inflation expectations matter to the behaviour of households and firms, the critical aspect of monetary policy is how the decisions of the central bank influence those expectations. As Michael Woodford has put it, “not only do expectations about policy matter, but, at least under current conditions, very little else matters”. Indeed, one can argue that the real influence of monetary policy is less the effect of any individual monthly decision on interest rates and more the ability of the framework of policy to condition inflation expectations. The precise “rule” which central banks follow is less important than their ability to condition expectations. That is a fundamental point on which my later argument will rest. It should be clear that, just as Maradona could not hope to score in every game by running towards goal in a straight line, so monetary policy cannot hope to meet the inflation target by leaving official interest rates unchanged indefinitely. Rates must always be set in a way that is consistent with the overall strategy of keeping inflation on track to meet the target; sometimes that will imply changes in rates, at other times not. Learning and its implication for monetary policy The academic literature on monetary policy rules has performed a great service in emphasising the importance of expectations. But there are two basic problems with the use of rules. The first is that the validity of any given rule depends upon the model of the economy that underlies it being true.