Indeed, under the Alternative Story, there could well be challenges for monetary policy, which in its modern mode operates essentially by using Bank Rate to regulate aggregate demand relative to aggregate supply, exploiting a short-run trade off between growth and inflation so long as inflation expectations are well anchored. If aggregate supply were to become endogenous in the way I have described, the short-run trade off might well be less pronounced for a while. That would make it harder to judge inflationary pressures from gauging the amount of slack in the economy; and harder for the Bank to achieve our 2% inflation target by broadly steering demand conditions. In that scenario, it would matter enormously that wage and price setters continued to act on the basis that CPI inflation would remain in line with the 2% target over the medium term. For me, both the Orthodox and Alternative Stories are plausible. In that sense, I think the outlook is ‘bimodal’ – in terms of there being two main stories. The Orthodox Story, to which I gave most weight in my November vote, required a small tightening. The implications of the Alternative Story for policy were less clear. I concluded that it was essential for the MPC to act in a way that was most likely to keep inflation expectations anchored.
There are also rigidities in the economy that mean that it will take time before a sharp fall in exports can be replaced by an increase of exports or by an increase of domestic demand that fully compensates for this decline. I actually think it is more reasonable to concentrate the negative effect on potential GDP to the period immediately after the start of the financial crisis, rather than to spread it out over a larger number of years before and after the financial crisis in the way that both the HP trend and the PF approach do. This would mean that the GDP gap would not appear so high in 2008 and perhaps not so low in 2009 either. But this is unimportant for the assessment of resource utilisation this year. Resource utilisation is largely normal My assessment is thus that resource utilisation is largely normal. The measures of resource utilisation that I showed earlier in Figures 8 and 9 indicated this. But it is also supported by other measures of resource utilisation, based on questions to individuals and companies. An additional advantage of measures of this type is that they can be seen directly in the statistics, thus avoiding the problems associated with HP trends and PF approaches. Figure 11 shows such a measure, capacity utilisation in the manufacturing sector from Statistics Sweden (SCB). It is now more or less on the average level for the period 1996–2008.