For example, a positive supply shock – as a result of technological progress, for instance – could keep inflationary pressure low for a prolonged period. Expansionary monetary policy conditions could therefore be maintained. But if we look at financial stability, this situation entails the risk of a boom-bust cycle, which would require a tightening of monetary policy. A similar problem is conceivable if the economic outlook is so poor that raising interest rates would be inappropriate because of the risk of deflation. However, maintaining low interest rates would pave the way for potential imbalances, which – from the point of view of financial stability – would actually have to be countered by raising interest rates. Such situations make it clear that a single instrument cannot simultaneously achieve two objectives. A further problem is that a bubble is not easy to identify. Expecting us to be able to tell in advance whether damaging price imbalances are building up within certain asset classes is not realistic. First, that would require us to be better than market forces in assessing the fundamentally justified value of a specific asset. Second, it is not easy to clearly identify which variables are to be used as indicators of imbalances. A third problem is that we do not yet have any sound knowledge of the timing, effectiveness and required scope of the monetary policy response that would be necessary to counter financial imbalances.
For example, recent work using the New York Fed’s Survey of Consumer Expectations shows a decline in longer-run inflation expectations by nearly half a percentage point over the last six years, to about 2-1/4 percent.7 This decline reflects both the low CPI inflation of recent years and demographic shifts, where members of older cohorts with high expectations (I’m afraid to say) die off. 2/4  BIS central bankers' speeches  If inflation continues to underrun target levels similar to the past six years, the downward trend in inflation expectations will likely continue. But there is still time to avert this fate—in this case, it’s fortunate that the young are impressionable. If inflation is sustained at target levels consistently, a further downward trend in expectations can be forestalled. But expectations depend on deeds, not just words, which brings me to the issue of accountability. One reason inflation targeting has been so successful at keeping inflation low and stable is that policymakers held themselves accountable for consistently delivering low inflation near the target. Finally, as well as holding ourselves accountable, policymakers need to be transparent and communicate their actions and the rationale behind them. Much has been made about whether central banks can credibly commit to future actions and outcomes, but the experience with inflation targeting gives me encouragement. Inflation-targeting central banks have proved beyond a doubt that they could bring inflation down and keep it low and stable. This was not a foregone conclusion, and initially there were doubts about whether inflation targeting would succeed.