In particular, the risks from continuing global price pressures and the effects of the prolonged period of above target inflation meant that the level of demand consistent with achieving the inflation target had probably fallen. Nasty reasons rather than nice ones.15 I should stress that I’m not at all certain that this will turn out to have been the right policy decision. A key lesson I learnt from the financial crisis is that economists know a lot less about the economy and how the economy works than many would like to believe. Policymakers need to approach their task with humility and pragmatism. If growth turns out to be materially weaker than I anticipate or other medium-term pressures on inflation ease unexpectedly, I will reverse my decision. But with growth expected to be around its average historical rate, inflation likely to remain above 4% for the rest of this year and Bank Rate at record low levels, some withdrawal of policy stimulus seems sensible. The juxtaposition of high inflation and loose monetary policy means that there is an onus on the MPC to explain its actions. The case for the defence needs to be made. And we have a good story to tell. We can explain why inflation has been above target for much of the past few years. We think we understand – albeit with the benefit of hindsight – why we have been surprised by the strength of inflation. And we have learnt from those episodes.
Rates of inflation expected to prevail in 5 or 10 years may not increase, but inflation expectations 2, 3 and 4-years ahead may well do. This risk is almost impossible to monitor since information on the term structure of inflation expectations, especially for households and companies, is very sparse. But it could have profound implications for the inflation outlook and the performance of our economy. If companies and households expect inflation to return to target quickly they will set their prices and pay demands accordingly. And in so doing, monetary policy has less to do – in terms of varying the level of demand in the economy – to ensure that it does. Inflation credibility is self reinforcing. The credibility gains associated with the move to inflation targeting and an independent policymaking committee in our country led to a reduction in the persistence of inflation. Inflation came back to target more quickly and the cost of it doing so in terms of output volatility was reduced.14 If companies and households begin to expect that  11  Brazier, Harrison, King and Yates (2008). 12  Carroll (2003). 13  Mankiw and Reis (2002). 14  There was a reduction in the persistence of UK inflation without an increase in the volatility of output. Benati (2006) found that the inflation targeting period has been the most stable macroeconomic period in UK history.