But that knowledge is required also for a forecast for inflation, and so the NAIRU itself provides no additional information over that contained in the forecast. Indeed, estimates of the NAIRU could be described as a by-product of the process of forecasting inflation. As an example, consider the impact of the appreciation of sterling from mid-1996 until late 1997. Retail price inflation can be thought of as a weighted average of domestic and imported inflation. The substantial real appreciation of sterling since mid-1996 has for a while reduced the imported component of UK inflation and so, in turn, retail price inflation, below the level that it would otherwise have reached. In essence the NAIRU fell relative to the natural rate. That restraining effect on inflation will gradually wear off and begin to be reversed if sterling continues to fall. The issue of whether the domestic inflation component would fall to a level consistent with the inflation target by the time this temporarily depressing effect wore off was central to the monetary policy debate during the summer. The example of sterling’s appreciation shows how a macroeconomic shock, entirely independent of the labour market, can affect the relationship between the rate of unemployment and the rate of inflation. The rise in sterling is likely to have reduced the NAIRU via two separate channels. First, in the short run, the relationship between domestically generated inflation – of which wage inflation is a substantial element – and retail price inflation shifts because of lower imported inflation.
This differs from the natural rate when macroeconomic shocks affect the rate of inflation corresponding to any degree of excess demand in the labour market. Since the NAIRU represents the current reduced-form relationship between inflation and unemployment, it is possible to calculate the prospects for inflation without any need to refer to such a variable as the NAIRU. It is a convenient shorthand concept for purposes of exposition, but not a necessary tool for operational decisions on interest rates. Second, the contribution of monetary policy to employment objectives is to promote economic stability in its broadest sense. I referred at the outset to Keynes’ view that the “triple evils” of an unequal distribution of income, instability of expectations and unemployment were all related to an unstable and unpredictable monetary standard. The solution, Keynes suggested, was to set monetary policy to hit a target for prices, or a low and stable inflation rate. He argued 75 years ago that monetary policy should be devoted to regulating the supply of money so that “the index number of prices will never move far from a fixed point”. Keynes went on to say that: “The Bank of England since the war has always done exactly the opposite of what the latest science recommends. I conclude from this that their opposition comes, not from mere obstinacy BIS Review 103/1998  – 10 –  or conservatism, but from their not yet understanding the point.