The choice of a horizon over which to bring inflation back to target is equivalent to choosing a point on this volatility trade off. The striking change, however, is the remarkable improvement in the trade-off that followed the introduction of inflation targeting, as can be seen in chart 6. The volatility of both inflation and output growth were much lower than in earlier periods. Part of the improvement may lie in the pattern of shocks over the past decade, although the world economy has hardly contributed to that stability. So the challenge ahead is that if a shock, larger than we have experienced recently but not large relative to historical experience, were to move inflation significantly away from target, then inflation expectations might become dislodged from the target. The behaviour of expectations and so the economy as a whole would change. So far there is little sign that the shocks we have experienced have detached inflation expectations from the target, and that is a source of comfort. But the MPC will continue to pay particular attention to the evidence on inflation expectations. Many of the problems of the past resulted from the failure to take action before expectations had started to drift upwards, and the cost of that inaction proved to be high.
The story of monetary policy in Britain during the intervening period is told by the Mais Lectures. The first Mais Lecture was delivered by my predecessor, Lord Richardson, in 1978, at a point when monetary policy was emerging as the main tool to deal with inflation. Not before time, you might think, since only two years earlier inflation had reached 27%. In 1981 the Chancellor of the Exchequer, Geoffrey Howe, chose as the title of his Mais Lecture: “The Fight Against Inflation”. As he said then, with inflation still in double figures, "squeezing inflation out from an economy which has become accustomed to higher rates over a period of years cannot be an easy or painless task. … the inflationary mentality must be eradicated. … When we have done that we will find that low inflation or even price stability need not be painful". The conquest of inflation was to prove harder than expected. In the decade that followed Geoffrey Howe’s lecture, inflation averaged over 7% a year. Only since 1992 has inflation fallen to levels that could be described as price stability. In retrospect, two Mais Lectures seem to have been of particular significance: those by Nigel Lawson in 1984 and by Tony Blair, then Leader of the Opposition, ten years ago this month. Despite clear differences of view, what stand out from those two lectures are their similarities. Both emphasised the need for a medium-term framework for monetary and fiscal policy.