Our remit from the Chancellor of the Exchequer tells us that our target is 2% inflation “at all times”, but also recognises “that the actual inflation rate will on occasions depart from its target as a result of shocks and disturbances. Attempts to keep inflation at the inflation target in these circumstances may cause undesirable volatility in output.” Economists and monetary policy makers have long understood that there is generally no conflict between stabilising inflation and stabilising output when the economy is subject to adverse demand shocks. But that there is a real choice to be made when there are adverse cost shocks: inflation can be stabilised, but only at the cost of volatility in output. From a monetary policy perspective, the rise in commodity prices and VAT are both essentially adverse cost shocks. And so, in my view, is the rise in import prices associated with the depreciation in sterling, given that it was not primarily a consequence of monetary policy actions (though the subsequent stance of monetary policy will surely have affected the extent to which that rise in import prices has passed through into consumer prices). The exercise above suggests that together they account for a rise in the level of consumer prices of 9 to 13 percentage points. Since the “excess” inflation relative to the 2% target is a little over 5 percentage points, that suggests that, in practice, we have ended up accommodating around half the impact of the shocks on inflation.
But even abstracting from the snow, activity seems to be have been broadly flat. How much should we read into that? One possibility is that the figure is simply erratic or will be revised away in due course. But other indicators – particularly some measures of consumer and business confidence – also weakened during the second half of the year,  3  While some outside commentators regarded that projection as being on the optimistic side, it would still have left output below its pre-crisis level until 2011 Q4 and broadly in-line with the average experience after banking crises recorded by the IMF (Chart 1). 2  BIS central bankers’ speeches  suggesting that something more substantial may have occurred. It could just be a short-lived soft patch – after all, recoveries are rarely smooth. Indeed, that is the judgement incorporated in the projections we published a couple of weeks ago (Chart 2). But it could instead be the harbinger of a more durable slowing – only time will tell. Let me now turn to the sources of the recent elevated inflation and the chances of inflation remaining above our 2% target into the medium term and beyond. A year ago, in our February 2010 Report, our central expectation was that inflation would be around 1% in the first quarter of this year. Yet in January, CPI inflation reached 4% and is likely to move higher in the coming months, in part reflecting the recent surge in oil prices.