Note, however, that inflation measured with UND1X is not affected; the rate remains stable around 2 per cent throughout the period. Neither are any monetary policy measures taken in this example, as long as inflation expectations do not change. The reason is that by the time a repo rate cut would elicit effects, the tax changes would no longer be affecting the inflation rate. This is evident from the absence of any effect on underlying inflation. Initially, moreover, the interest expenditure item in the CPI would move in the ‘wrong’ direction and lower CPI inflation even more. If medium-term inflation expectations were to be influenced, on the other hand, monetary policy action might be called for. An adjustment of expectations in the light of the tax change has consequences for underlying inflation, so that inflation may be below the target somewhat further ahead. 7  BIS Review 61/1999  9. Permanent and transitory inflation A schematic account Initial position Economic development stable, underlying inflation UNDINHX - in line with the target. 4  3 UNDINHX  Good coffee harvest and increased supply of oil. These commodities’ prices fall sharply in July year 0 and are then stable at the new, lower level. •CPI-inflation is lowered for a period of twelve months and so is UND1X. •But underlying inflation measured with UNDINHX remains stable.
In such a context there is a risk that the banks could act even more procyclically than they usually do and would amplify the cycle. To be clear, the uncertainties and the economic slowdown have so far not caused banks to tighten their lending conditions or to grant less credit. But we need to keep a very close eye on how this evolves. How will the banks behave if the economic slowdown continues? Would you say that financing conditions in the euro area as a whole have already tightened significantly? Financing conditions have tightened somewhat in recent months, but not significantly, thanks in part to our forward guidance on interest rates. This partly compensates for such effects. But you’re absolutely right, we as central bankers must always ask ourselves whether our monetary policy stance is appropriate for us to attain our objective. And what is your answer at the moment? We have revised our assessment of risks to growth downward. I would say that is a clear indication that the level of alert is higher than before. 2/5  BIS central bankers' speeches  Three quarters of below-potential growth, higher risks and at least slightly tighter financing conditions – what does that signify for the inflation outlook? Is the ECB’s Governing Council losing its confidence in reaching the target of 2% over the medium term? Three quarters of below-potential growth are certainly not good news. But we have a medium term perpective.