First, since the global financial crisis, the UK economy has been subject to a series of major supply shocks, which, for reasons that I will explain, create a tension between short-term inflation and output stabilisation. And second, there has been a renewed recognition that, in extreme circumstances, the monetary authority may have to take into account financial stability considerations in setting monetary policy with potential consequences for the short-term path of inflation control. These are big decisions, decisions subject to considerable uncertainty, and decisions which entail potentially large welfare costs, arising from high unemployment and unevenly distributed costs of inflation. They deserve scrutiny to ensure that they are consistent with society’s preferences as expressed in statute and remit. 1. Monetary policy remit For most of the Bank’s history, an assessment of whether it was acting in a way consistent with society’s view of the public good could not be made. As former Governor Eddie George remarked, during the half century that followed its nationalisation in 1946 “the Bank operated under legislation which, remarkably, did not attempt to define our objectives or functions.” 7  They were, instead, “assumed to carry over from [the Bank’s] earlier long history.” In that regard, the Bank’s ‘constitution’ resembled that of the United Kingdom more broadly, comprising a rich history of law, principle and convention.
Exogenous changes  0.5  in firms’ pricing power are one example – so-called cost-push shocks. Shocks to the exchange rate, the  0 Source: Bank calculations. economy’s supply capacity, or commodity prices also  10  See Blanchard, O., and J. Galí (2007). "Real Wage Rigidities and the New Keynesian Model". Journal of Money, Credit, and Banking, 39(1), pp. 35-65. 11 See Broadbent, B (2013), “Conditional guidance as a response to supply uncertainty”, speech at the London Business School. 6  All speeches are available online at www.bankofengland.co.uk/publications/Pages/speeches  6  Chart 2: … whereas after the financial crisis, the economy experienced a challenging monetary policy trade-off  have this flavour. 12  Because monetary policy’s  influence on inflation is predominantly an indirect one, via demand, in such circumstances inflation can only  Financial crisis and after  6  Inflation (%)  be controlled by delivering an opposing movement in aggregate spending. If something pushes up on  5  inflation directly, monetary policy can only bring inflation back down by causing a reduction in  4  spending via higher interest rates. The speed with 3  which this adjustment is delivered is determined by the monetary policy maker guided by their remit.