And away from home, central banking is undergoing considerable change: both the Federal Open Market Committee (FOMC) in the United States and the Bank of Japan have recently made policy changes that emphasise their commitment to provide further monetary stimulus until their economies recover. Against that backdrop, people are understandably asking what role monetary policy in the UK should play in determining growth and inflation? This is an important debate and one that is likely to be central to economic policymaking over the next few years. What I would like to do today is to offer some of my own thoughts on this issue. I want to focus on two aspects in particular. The first concerns the objectives of monetary policy. The inflation target, given to the MPC by the UK government, states that our primary objective is to ensure that CPI inflation is equal to 2%. But it also makes clear that, in so doing, we should be mindful of the implications that our policy actions have for growth and employment. How should we go about reconciling those different objectives? The second issue relates to the current operation of monetary policy. What should we make of the view, repeated in many quarters, that the trade off between growth and inflation may be unusually favourable in present circumstances. That we could buy quite a bit of extra growth at little or no cost in terms of higher inflation? Do such free lunches really exist?
5  King (2012) and Tucker (2012) make similar arguments in the context of financial stability and the role that the newly formed Financial Policy Committee can play in this respect. 4  BIS central bankers’ speeches  The second possibility is that the effective capacity of the economy to supply goods and services depends on the state of demand: the stronger the demand, the greater somehow the capacity of companies and employees to meet it. The likely responsiveness of supply to an increase in demand, it’s argued, means that it would be possible for the economy to grow relatively rapidly without significantly reducing the degree of slack in the economy and so without adding markedly to cost and price pressures. Let’s consider briefly each of these possibilities in turn. The suggestion that the Phillips curve may be relatively flat appears, at least at first blush, to be consistent with our experience over recent years. Following the worst recession in living memory, our economy has barely grown over the past two years. Output is well below its pre-crisis level, unemployment close to 8%. But inflation remains stubbornly above target. The trade-off between output and inflation has indeed been remarkably flat. But that doesn’t mean that the flatness of this trade-off can be relied upon to continue in the future: it depends on why inflation has been so sticky. Much of the slack in our economy is concentrated in the labour market, where unemployment remains painfully elevated.