That survey does not refer to a specific price index, so given that the average wedge between perceived inflation in the survey and actual CPI inflation is 1 percentage point, the proportion refers to the households that expect that inflation will be 3% or higher two years ahead. BIS central bankers’ speeches  9  risk derailing recovery by tightening and being unable then to course-correct. I have considerable sympathy with this risk-management approach. Table 3 provides an illustrative list of countries which have pursued the latter strategy – tightening during a post-crisis recovery and then course-correcting. The most celebrated (if that is the right word) was the Fed’s tightening in 1937. This is felt by many to have sent the US economy back into recession (Friedman and Schwartz (1963)). Almost 80 years on, the scars from that experience have yet to fade. The US experience in the 1930s was special, but not unique. In few of the cases in Table 3 did things go well. In each case the tightening was subsequently unwound. In a number of cases it had to be more than unwound due to its contractionary effects on the economy. Chart 19 shows the average path of output either side of the tightening. Most of these countries experienced several years of robust growth prior to the tightening, suggesting the economy was primed for lift-off. Yet when lift-off came, annual output growth weakened by around 2 percentage points in the following year, in the US by much more.
If there is no risk premium, the uncovered interest rate parity relates interest income in the domestic economy with interest income in the foreign economy via the expected change in the exchange rate. For a better understanding we may use the example of our current situation. The one-year interest rate in the Eurozone is slightly above 4%, while the Czech one-year interest rate is less than 3%. In spite of this negative interest rate differential we still see many investors holding Czech crowndenominated assets. Why? Simply because financial market participants expect the Czech crown to appreciate in the future and thus compensate for the negative interest rate differential. Although the uncovered interest rate parity has been heavily criticised and disapproved as being practically non-functioning, it is used in macroeconomic models. Well, as an economic modeller you simply do not have any other option. The uncovered interest rate parity is directly implied by the profitmaximising behaviour of financial market participants. We probably all agree that the behaviour of financial market participants is led by profit maximisation (given the level of risk). At the same time, however, surely at least a few of you here in the audience would seriously argue that a relationship such as the uncovered interest rate parity does not hold in reality and that it is a purely theoretical concept. The uncovered interest rate parity is, however, implied by the profit-seeking mechanism.