That left two possibilities: joining the eurozone after a negotiated agreement and continuing with a flexible exchange rate and an inflation target. The problem was that there were drawbacks to both. The financial crisis had uncovered flaws in the design of the eurozone, and it also came to light that political support for eurozone membership was lacking. Independent monetary policy and a flexible exchange rate had not been very successful. Has something changed? The euro area is still putting in place the reforms deemed necessary for it to function smoothly, and it does not seem to me that political support for membership has increased significantly since the Bank’s report was issued. But various reforms have been made to monetary policy conduct in Iceland, and financial stability policy has been vastly improved. Much of what I have called inflation targeting plus has already been put in place. And in the past few years, we have seen that independent monetary policy can work effectively, also in Iceland. This is where we are now. That need not mean that we will be here for the indefinite future. There is no eternal monetary solution, and various options develop over time. 4  See reference in Footnote 3. 10
First, looking back over the past three years, the big picture is that inflation has stayed surprisingly low, and output growth remarkably stable, given the scale of these cost increases. Inflation has never deviated by more than 1 percentage point from the 2 per cent target. But second, judging by the media and public reaction to the rise in inflation over the past few months, it is clear that even a small deviation in inflation from target can now look very significant after the stability of the past decade. This illustrates both the helpful and unhelpful legacy of a decade of remarkable stability for the UK economy. On the helpful side, there is no doubt that a highly credible monetary policy framework has helped to contain inflation, in the face of a very large cost shock. The UK has become a low inflation economy since the 1970s and people expect the MPC to keep it that way. That affects the way they behave when they take decisions about wages and prices. The less helpful legacy is that even a small movement in inflation away from target – one percentage point – has prompted some highly coloured media coverage, and may have unsettled people’s expectations about where inflation is headed in the short run. How does this less helpful legacy affect the policy debate?