10  BIS Review 36/2005  Table 2: The persistence of inflation 1950-2005 Persistence 1950-59  0.5  1960-69  0.3  1970-79  0.7  1980-92  0.8  1993-2005  0.2  Source: ONS and Bank of England calculations. Note: Persistence in this table is the sum of the coefficients on lagged inflation in a regression of quarterly inflation on a constant and 4 lags. The measure of inflation is RPI before 1976 and RPIX from 1976, seasonally adjusted. Chart 4: Catching a cricket ball  ball A  F  BIS Review 36/2005  11  Chart 5: The variability of expected future interest rates, US and UK Basis points 20  15 US  10  5 UK 0 1992  1994  1996  1998  2000  2002  2004  Source: Bank of England calculations. Note: variability is calculated as the standard deviation of daily changes in the ten year instantaneous nominal forward rate over a yearly window. 12  BIS Review 36/2005  Chart 6: The variability of inflation and output, 1955-2004 standard de viation of inflation, pe r cent  8 A  7 1970-1979  6 5 1980-1992  4 3 1955-1959  2 A  1960-1969  1  1993-2004  0 0  1  2  3  4  5  6  7  8  standard de viation of GDP growth, pe r cent  Source: ONS and Bank of England calculations.
Over twenty-five years we have moved from monetary targets to an inflation target and from a medium term financial strategy to rules for fiscal policy over the cycle. Yet the essential objective of maintaining monetary and fiscal discipline remains the same. All major political parties in the UK now agree that stability is the key to economic success. We do not know whether the Great Stability will continue, as it has for more than a decade now. In part, it will depend upon whether our framework of inflation targeting can respond to the economic shocks that will undoubtedly be visited upon us in the years ahead. And that is the subject of my lecture. In only fifteen years inflation targeting has taken the central banking world by storm. Table 1 shows that there are now 22 countries in which monetary policy is based on an inflation targeting regime. So tonight I want to discuss what inflation targeting really means, why it has been successful in Britain and elsewhere, and what challenges it faces in the years ahead. The lecture tries to answer three questions. First, what can monetary policy do and how has our understanding of that changed over time? Second, what are the challenges for central banks that result from incomplete knowledge of the transmission mechanism of monetary policy? Third, is inflation targeting the answer to those challenges? I believe that it is. Inflation targeting, I shall argue,  1 2  This proposition is documented in detail by Batini and Nelson (2005).