Following a further depreciation in the currency, rises in administered prices and the prospect of continued weak growth in productivity, inflation was thought “likely to remain above target for much of the forecast period”. But “attempting to bring inflation back to target sooner…would risk derailing the recovery” and it was therefore “judged appropriate to look through the temporary, albeit protracted, period of above-target inflation”. I don’t think this was so exceptional. There is no inflation-targeting monetary authority that behaves so rigidly as to attempt to offset all shorter-term shocks to inflation, no matter the effects on the variability of interest rates and output. As the economist Lars Svensson puts it, “in practice, inflation targeting is always ‘flexible’, because all inflation-targeting central banks not only aim at stabilizing inflation but also put some weight on stabilizing the real economy”. In the UK, this regard for the occasional trade-offs faced by monetary policy, and their implication for the planning horizon, was formally enshrined in the MPC’s remit in March 2013. The Committee is now required to “promote understanding of the trade-offs inherent in setting policy and… [to communicate] the horizon over which it is appropriate to return inflation to the target”. This description of the appropriate horizon is now a regular part of our communication, notably in the newly introduced Monetary Policy Summary that introduces both the Inflation Report and the Minutes of our meetings. What of the current situation?
If the central projection’s a long way from target, that can tell you something about the MPC’s view of the suitability of the yield curve – given, at least, all the other assumptions in its forecasts. In May 2009, after the first slug of QE, the Inflation Report forecast was well below target. This suggested that, unless the economy improved much faster than it expected, the Committee believed that monetary conditions would need to be looser than implied by the yield curve at the time. As things turned out, that’s exactly what happened. But there are limits to how far this kind of reasoning should be taken. One particular problem, when it comes to the so-called “lift-off” date for interest rates, is that the yield curve is currently very flat. As a result, even relatively moderate changes in forward rates, prompted by unexceptional news about the economy, can result in big shifts in the date at which the yield curve first reaches some particular level. But that doesn’t mean the MPC’s views about future policy have moved so dramatically. If nothing else, this demonstrates the problem with focusing too obsessively on that particular date. More generally, the MPC’s inflation forecast is a far from perfect indicator of interest rates. It involves lots of conditioning assumptions, not just forward interest rates, and any of these can change. Our understanding of the economy evolves over time and the economy itself is always subject to unforeseeable shocks.