But we are sensitive to the fact that certainly over the past two or three years price pressures in both product and labour markets have been less than we would have expected based on earlier experience, given the strength of demand. You might explain this in terms of more intense competition and lower margins in product markets; or in terms of an increase in the rate of productivity growth, perhaps related to the application of new technology, such as we have seen in the US; and you might explain the recent relatively benign real earnings growth in terms of the more flexible functioning of labour markets. But we cannot be sure of the explanation, nor of how large or persistent the relevant effects will prove to be. We are nevertheless sensitive to these possibilities; we do indeed try to allow for them in our forecasts and in our policy judgements, based upon careful scrutiny of all the latest information that we have. But the process remains necessarily judgmental, and that, of course, leaves us vulnerable to assertions that we don’t give sufficient weight to this or that factor. That, some of our critics maintain is why inflation has been below target for much of the past two years. In fact the undershoot has been marginal – given the uncertainties - and can just as well be explained by the unexpected strength of sterling’s effective exchange rate, reflecting the weakness of the euro, which has both directly dampened the price level and constrained external demand.
There are really three key areas: •  First, there is uncertainty about what in fact is happening on the supply-side of the economy, that’s to say how rapidly can aggregate demand be allowed to increase before it begins to run ahead of supply and put upward pressure on inflation or, alternatively how rapidly must demand increase in order not to run below supply-side capacity and cause inflation to fall significantly short of the inflation target. The target is, of course, symmetrical;  •  Secondly, and specifically in relation to the labour market, at what point does the growth of employment or the fall in unemployment lead to a rate of increase in pay settlements, or earnings growth, which would subsequently lead to accelerating inflation in goods and services markets; and  •  Thirdly, what is happening or is likely to happen to the rate of growth of aggregate demand in the economy anyway. Now, as I said earlier, there is not a great deal that we – through monetary policy – can do directly to affect the first two of these areas of uncertainty, which relate to the supply-side of the economy. The major challenge for us in these areas is in assessing – or quantifying – their impact. And that’s not at all easy because, while the effects gradually become apparent over time, many of the relevant developments cannot be directly observed or measured; nor therefore can they be predicted with any great confidence.