That hardly characterises the UK in the past five years, where inflation has averaged well above our 2% target and the real interest rate has as a consequence been pretty low. Moreover, it is by no means obvious that the UK’s economic problem is simply one of deficient aggregate demand. The limited disinflationary pressures coupled with consistently weak productivity growth suggest that the financial crisis may have wrought significant damage to the supply side of the economy. Our November Inflation Report discussed a variety of possible explanations for the weakness in productivity, relative to a continuation of its pre-crisis trend. Some of the weakness may unwind naturally as the recovery gathers pace, some may require policy intervention to fix, and some may persist indefinitely. But it seems unwise to assume that all of it will unwind with a recovery. That part of it which is attributable to a supply-side deterioration will instead be absorbed as a higher price level under a nominal income target. Of course, this issue could be addressed by adjusting the target level of nominal income down for the presumed deterioration in supply, but unfortunately we do not presently have a good handle on just how big this is.
In particular, the collapse in demand after the demise of Lehman Brothers was so sudden and deep that there was no way that monetary policy could in practice have been relaxed early enough, and by a large enough amount, to prevent it. It is, though, a moot point whether policy would have been set even more stimulatory during the latter part of 2009 if we had been operating under a nominal income growth target, given that we were implicitly expecting a rather slow recovery in nominal income growth. Given how stimulatory policy already was, I suspect that we might well have taken the view that it was simply not feasible to get nominal income growth back much faster. The unexpected weakness of nominal income growth in the past year or so does, however, serve to highlight a more significant difference between an inflation target and a nominal income growth target. A remarkable feature of the current cycle has been the juxtaposition of a weak recovery in output with robust growth in employment. One possible explanation is that the financial crisis has led to a fall, possibly temporarily, in the underlying rate of growth of supply. If that is so, then a fixed nominal income growth target would obviously go hand-in-hand with a higher inflation rate, whereas a fixed inflation target would be associated with lower nominal income growth. But this hardly provides an argument in favour of a nominal income growth target.