The idea behind an efficient monetary policy can be illustrated using a modified Taylor curve, named after the economist John Taylor. 6 As I have said, under a flexible inflation targeting  4  Adolfson, Malin, Stefan Laséen, Jesper Lindé and Mattias Villani (2008), "Evaluating an Estimated New Keynesian Small Open Economy Model", Journal of Economic Dynamics and Control 32, p. 2690-2721. 5  Material for assessing monetary policy 2006-2008, Sveriges Riksbank, www.riksbank.com. 6  The original Taylor curve relates to variances of outcomes ex post. Se Taylor, John B. (1979), "Estimation and Control of a Macroeconomic Model with Rational Expectations." Econometrica 47, p. 1267-86. A modified  6  BIS Review 29/2009  regime the central bank aims to stabilise inflation and resource utilisation; that is to minimise the deviations from the inflation target and the normal level for resource utilisation. In Figure 3, the sum of squares for the inflation-gap forecast is measured along the horizontal axis and the sum of squares for the output-gap forecasts along the vertical axis. The curve through points A, B and C is the modified Taylor curve, that is, all the efficient combinations of forecasts for inflation and resource utilisation respectively that it is possible to achieve in a certain decision-making situation with the help of different interest rate paths. Points to the left and below the curve cannot be reached due to the initial state of the economy and the transmission mechanism between inflation, resource utilisation and the repo rate.
This is what I intend to talk about today. What should we consider when we evaluate monetary policy? What are the principles for a good  1  The evaluation of monetary policy in New Zealand and Norges Bank Watch 2002 are available on my website: www.larseosvensson.net. BIS Review 29/2009  1  evaluation of monetary policy and what is practically possible? How can principles and practice be developed compared with how evaluations are carried out today? Here I present a number of preliminary proposals for such development. Why not just examine whether inflation deviates from the target? An increasing number of central banks focus their monetary policy on achieving an inflation target. My discussion today will therefore be about evaluations of monetary policy with an inflation target. Given this, you may ask why an evaluation of monetary policy should be so complicated. When there is an inflation target, is it not simply enough to compare the actual outcome for inflation with the inflation target; that is to evaluate monetary policy after the fact? There are at least two circumstances that make such an evaluation inadequate. Unforeseen shocks affect outcomes First, monetary policy does not provide complete control over inflation. A central bank is therefore unable to ensure that inflation will be exactly on target at every point in time. In actual fact, monetary policy is conducted under conditions of great uncertainty.