17 Inferring policy preferences from the MPC’s published forecasts in this way is not necessarily straightforward, however, because the MPC’s forecasts are conditioned on the market-implied path for interest rates. Implicitly, then, the assumption would be that the MPC’s forecasts and reaction function are, on average, well understood by the market. 18 This assumes a Phillips Curve slope, 𝜅, of ½. The lines of best fit in Charts 1 and 2 have slopes of around minus 0.3 for the period as a whole and minus 0.55 over the post-crisis period. With a value of 𝜅 = 0.5, this suggests 𝜆 of between 0.1 and 0.2 for the whole period and 𝜆 of around ¼ for the crisis period alone. 10  All speeches are available online at www.bankofengland.co.uk/publications/Pages/speeches  10  To put this into some context, consider the stated and revealed preferences of the FOMC. Chair Yellen has referred to a “balanced approach” to trade-off management, implying equal weights on inflation deviations and the unemployment gap. 19  Econometric studies for the US provide a range of estimates for lambda,  centred around ½ albeit with significant estimation uncertainty, with some studies finding evidence that the FOMC’s implied lambda has also varied over time. 20  4. Why there isn’t a simple rule to achieve society’s inflation objective? This exercise illustrates how the MPC has sought to do what society has asked.
In the simplest New Keynesian model, these are, first, the “IS” curve, which traces a negative relation between output and the (ex-ante) real interest rate (𝑖𝑡 − 𝐸𝑡 𝜋𝑡+1 ): 1 𝑦𝑡 = 𝐸𝑡 𝑦𝑡+1 − (𝑖𝑡 − 𝐸𝑡 𝜋𝑡+1 ) 𝜎 This equation comes from the optimisation problem of households who choose consumption to maximise their lifetime utility. 𝐸𝑡 denotes the mathematical expectations operator. The term in expected output, 𝐸𝑡 𝑦𝑡+1 , appears on account of households’ desire to smooth consumption. The real interest rate enters this condition because ultimately households care about their real consumption levels and it is the real interest rate that is relevant for transferring these consumption levels, via saving, across time. The parameter 𝜎, the intertemporal elasticity of substitution, controls the size of this effect. 31  In the simplest monetary models, the natural level of output (or “trend output”, if you like), is exogenous (e.g. is determined by TFP alone).