In the years before the crisis, resource utilisation was probably higher than the HP gap indicated at that point. This view is also suggested by the fact that GDP growth was high, employment was increasing rapidly, underlying inflation was rising to above 2 per cent, and that household borrowing and house prices were similarly rising rapidly. (Figure 1. GDP gaps in September and in real time). This is a widely known problem that occurs internationally, and not just here. Orphanides says that one should not use the GDP gap as a measure of resource utilisation, due to the uncertainty in estimates of the gap. He shows, for instance, that the International Monetary Fund’s (IMF) calculations of the GDP gap for the United States at different points in time have yielded conflicting results with regard to resource utilisation and that these have therefore led to incorrect economic policy recommendations. He draws the conclusion that one should focus more on GDP growth than on the GDP gap, which, he claims, may provide more robust decision-making data. 2 There are also other ways of measuring resource utilisation. A common method is to use a production function where potential GDP is determined by potential labour productivity and the potential number of hours worked. Other possibilities include using so-called UC  2  See, for example, Orphanides, A. (2010) “Monetary Policy Lessons from the Crisis”, Central Bank of Cyprus, May 2010.
Central banks must also avoid misperception and for that reason, they should not rely on a limited set of indicators but should use a comprehensive and rigorous analysis aimed at picturing the economy as a complex and permanently evolving system. Central banks also have the difficult task of identifying shocks hitting the economy and of addressing them appropriately by assessing their potential implications in terms of risks to price stability. Model analysis, monetary analysis, model -based forecasts are additional useful tools employed in this context. This is precisely the approach taken by the ECB, which developed its two-pillar-strategy in order to help to sort through the wealth of potentially conflicting statistics. Conclusion Let me now briefly conclude my remarks by asking the question: what information do we really get from asset prices, and particularly from inflation - indexed securities? Financial markets do indeed play a critical role in the process of setting monetary policy. In effect, the influence of monetary policy on the real economy and ultimately on prices is largely transmitted through asset prices. As pointed out by Blinder, the economic activity is not directly affected by the changes in the key policy rates, but rather by long-term interest rates and, where relevant, through wealth effects. In short, monetary policy affects the economy through its interaction with long-term expectations, which in turns affect asset prices and then economic activity and inflation. But central banks also rely on financial markets for information to help explain their monetary policy decisions.