On the other hand, the postpandemic recovery in aggregate demand has been much stronger in the US, with a much tighter labour market. At the opposite end of the spectrum is what I would call the “academist approach” – although it comes from Lars Svensson, a one-time practitioner who was, among others, Deputy Governor of the Swedish Riksbank between 2007 and 2013. It would be to look purely forward and do inflation forecast targeting. The central bank then works out an interest rate path that is compatible with bringing inflation back to the target over the forecast horizon (and staying there). Simple models, such as the original Svensson’s one (1997)ii, can be inverted to find a single policy interest rate – “the target-compatible rate”. With more complex models, target-compatible paths can be found through interest rate scenarios. This approach is appealing in theory but raises several practical problems. First, it relies heavily on having a very accurate model and clear identification of the shocks hitting the economy, including how persistent these will be. The substantial forecast revisions over recent quarters underline quite how difficult it is to calibrate policy based on forecast targeting. A second, and more subtle, problem is the “stationarity” of most macroeconomic models. This is either true by assumption in standard New-Keynesian models or implicit in empirical forecasting models. For either reason, forecast inflation has a tendency to revert to the target or the historical mean under almost any scenario.
In this slide I plot a measure with fewer technical assumptions: it uses the nominal OIS curve and ILS swaps to create forward one-year real rates at horizons of 4 to 9 years; this can tell us where markets expect real rates to settle once current shocks have dissipated. The solid line shows the first principal component as an estimate of r* using this approach, with a real neutral rate now just below zero. Based on a target 6  Page 7 sur 14  inflation rate of 2%, the nominal neutral rate should then be a bit less than 2%. Given the fact inflation is far above target and still rising, we should reach this level before the end of the year. It is much more important to give the public this landmark than to spark speculation and public betting game on the size of the next move in October: this is why I won’t say anything today about this 50/75 bp discussion, which is premature especially in the current volatile market environment and the additional tightening of financial conditions. 2.2 A four-pronged approach for further interest rates decisions What will happen from that point onwards? We probably won’t stop raising rates there, but we will enter another part of the journey: a more flexible, and possibly slower one, relying on a meeting-by-meeting precise economic assessment.