If agents expect inflation to go down towards a target, they will price their goods accordingly and inflation persistence will be lower. If, in contrast, agents expect inflation to persist in high levels, they will price goods higher, making inflation more persistent and more difficult for the central bank to bring it down. As stated in Bernanke (2007): “a one-off change in energy prices can translate into persistent inflation only if it leads to higher expected inflation and a consequent “wage-price spiral”. With inflation expectations well anchored, a one-time increase in energy prices should not lead to a permanent increase in inflation, but only to a change in relative prices.” Credibility of the target in an inflation-targeting regime is therefore a key asset. If we were to give up on the inflation commitment, the future adjustment of interest rates to rein in inflation would have to be much larger, with adverse consequences on economic activity and relative prices, in particular the exchange rate. Indeed, we have witnessed many experiences where a persistent rise in inflation has required strong monetary policy actions, the most notable case being the great inflation of the USA in the 1970s and early 80s. The control of inflation in Chile has also come with a decline in inflationary persistence. Therefore, a credible commitment to price stability brings along output stability. Output stability, in turn, is an important factor to foster economic growth and the consequent social progress that comes with it (Ramey and Ramey, 1995, and Fatas, 2002).
Nor do I have any claim to originality – Milton Friedman and Anna Schwartz wrote in their monetary history of the US that the most notable feature of the revival of the US economy after 1933 was not its rapidity but its incompleteness[1]. I, and other MPC members, have also used the analogy of a bridge to describe the role of economic policy in the age of Covid, the bridge to the other side of Covid. We are still on that bridge. The rate of recovery has slowed over recent months, and that slowing is continuing. Relative to the fourth quarter of 2019, on the latest data to July, the level of GDP was 3.5% lower. That’s around one percentage point below the level consistent with the August Monetary Policy Report. There is a crucial distinction here between growth rates and levels of activity. It is inevitable in a bounce-back that the growth rate will slow as the recovery nears its end-point. It is not though inevitable – or desirable – that the previous level is not regained. Recovery in some consumer-facing services appears to have been delayed. We had seen a recovery in activities such as eating in restaurants, but activity is levelling off, notwithstanding our contribution this evening. Consistent with the impact of supply bottlenecks and disruption, construction output fell in July, and manufacturing output stalled. Surveys and the reports of the Bank’s Agents, suggest the impact of these supply-chain issues is broadening out.