Chart 25: Projection for wage growth and inflation, assuming inflation expectations put downward pressure on wages Wages - lower inflation expectations Wages - February IR projections Inflation - February IR projections Inflation - lower inflation expectations  14  6 4 2 0 -2 -4  Monetary policy If there is evidence that risks to inflation, globally and in the UK, may be skewed to the downside, the obvious next  Percentage change oya  Source: ONS and Bank calculations. BIS central bankers’ speeches  question is what, if any, monetary policy response might be appropriate as insurance against those downside risks. One insurance device comes from the specification of the inflation target itself. Even if the risks to inflation are asymmetric, central banks’ inflation targets typically are not. This reduces the risk of monetary policy imparting a “deflationary bias”. The MPC’s own mandate is crystal clear: deviations above and below the 2% inflation target are to be treated symmetrically. In its Open Letter to the Chancellor earlier this year, the MPC made clear it would act symmetrically to meet the inflation target.15 A second insurance policy against downside inflation risk comes from clearly specifying the horizon over which inflation is expected to return to target following a deviation. Provided that horizon is credible, this reduces the risk of inflationary expectations becoming dislodged from the target on a persistent basis.
Chart 30: Simulation of Bank rate and CPI inflation, if the starting level of slack is 2% Path for Bank rate  Per cent 1.5  Per cent 3  CPI inflation  2.5 1 2 1.5  0.5  1 0 0.5 2013  2014  2015  2016  2017  -0.5 2013 2018  February IR Simulation with a lower bound at 0% Simulation with a lower bound at 0.5%  2014  2015  2016  2017  0 2018  February IR Simulation with a lower bound at 0% Simulation with a lower bound at 0.5%  Source: ONS and Bank Calculations. Simulations show optimal policy under full commitment. Of course, there are good reasons why monetary policy is not set by algorithm. These simulations ignore a number of important practical uncertainties. For example, they assume that this policy path is fully credible and effective in stimulating demand and inflation expectations. In practice, the effects of a policy easing cannot be known with certainty and 18  BIS central bankers’ speeches  policy credibility cannot be guaranteed. Moreover, there are upside as well as downside risks to the inflation outlook. Nonetheless, these experiments are in my view the right baseline when assessing the appropriate policy stance today. Conclusion Inflation has dropped like a stone over the past year, to close to zero. This largely, but not wholly, reflects external forces.