In these circumstances, the Committee can extend the horizon over which it returns inflation to target if doing so achieves a better balance between the scale and duration of the deviation of inflation from target and the variability of output. This same framework can be used to think through the implications of the dominance of the US dollar in international trade and invoicing. In particular, in a DCP world with sticky dollar prices, a depreciation driven by strength in the dollar will tend to result in additional imported inflation. Rather than tightening monetary policy to offset fully that exogenous increase in imported inflation through lower domestic inflationary pressures, policymakers would do better to trade off inflation and output volatility, accepting some increase in imported inflation to achieve a smaller reduction in domestic demand below potential. The ability of new exporters to benefit from the depreciation by undercutting existing dollar contracts would provide some boost to exports and help lessen the trade-off facing the monetary policy maker. A similar strategy could be pursued in the face of large financial spillovers. The ability to do this depends heavily on the credibility of the monetary policy framework and the transparency with which the strategy is pursued. As I will go on to discuss, both can be reinforced by explicit recognition of the spillovers of the IMFS, particularly if recognised in IMF surveillance.
And the results slip reads pretty well. In particular, the inflation target was instrumental in anchoring the credibility of policy, without which the MPC would not have been able to respond so aggressively. Without credibility, there can be no flexibility. And the MPC has used that flexibility to the full, providing extraordinary levels of stimulus to support growth and jobs. But the nature of the inflation targeting framework meant that it dropped a few marks in terms of helping the MPC to communicate the role monetary policy played in supporting the recovery. That risked undermining the democratic legitimacy of inflation targeting. Likewise, the inflation target on its own was less suited to explaining the MPC’s view of the appropriate trade-off between the speed with which inflation is returned to target and the support provided to the fledgling recovery. The forward guidance announced by the Committee retains the primacy of the inflation target while allowing the Committee to more effectively tackle these communication challenges. In so doing it enhances the transparency and accountability of monetary policy. The guidance also provides a robust framework in which the MPC can explore the scope for economic expansion and helps to provide greater clarity about the likely path of monetary policy as the economy recovers. The inflation target remains front and centre in the conduct of UK monetary policy. Price stability remains the primary objective of monetary policy.