Charles Bean: Nominal income targets - an old wine in a new bottle
Speech by Mr Charles Bean, Deputy Governor for Monetary Policy of the Bank of England,
at the Institute for Economic Affairs Conference on the State of the Economy, London,
27 February 2013.
* * *
Good morning! The UK's inflation targeting regime came into being just over 20 years ago, in
the aftermath of sterling's exit from the Exchange Rate Mechanism. On the surface, the first
15 years looked pretty successful, with steady growth and inflation close to target. But we
now know that dangerous financial imbalances were developing below the surface, not only
here but also in other advanced economies. Those fault-lines have been brutally exposed in
the past five years, which saw the worst systemic financial crisis in a century, followed by a
deep recession and a tepid recovery that has left output still some 3% below its previous
peak.
That experience has fuelled the debate over the extent to which central banks should lean
against an asset-price and credit boom. Having discussed the issue elsewhere,1 I do not
intend to dwell on it today, other than to say that I believe the right response to such threats
is to rely primarily on the more active application of regulatory tools. But there will be
occasions - when the excesses are building up outside the regulatory perimeter, for instance
- when a more activist monetary policy leaning against the building financial imbalances will
also be required. So the central bank's mandate needs to permit a temporary undershooting
of its inflation target if it thereby reduces the risk of a subsequent painful bust.
The past few months have, however, seen questions asked of our inflation-targeting
framework for other reasons. According to some, the framework has constrained the ability of
monetary policy to support the recovery; an objective giving higher priority to growth or
employment might have produced a better outcome. A particular, and increasingly popular,
variant of this involves combining growth and inflation into a single target for nominal income.
The first thing to be said is that the MPC's mandate already incorporates a growth and
employment objective. While our primary objective is to maintain price stability, subject to
that we are also expected to support the Government's policies for growth and employment.
The Chancellor's annual remit letter puts flesh on those bones, by specifying not only the 2%
target for CPI inflation but also the Government's desire for high and stable growth and
employment. And the letter goes on to note "that the actual inflation rate will on occasions
depart from its target as a result of shocks and disturbances (and that) attempts to keep
inflation at the inflation target in these circumstances may cause undesirable volatility in
output." If we had tried to offset the impact on consumer prices of, say, sharp movements in
import prices, then we would need to engineer countervailing movements in domestically
generated costs, in particular pay. But, given the stickiness of pay and prices, that would
necessitate inefficient fluctuations in activity and employment.
Now during the first decade of the MPC, such shocks were small and generally benign, with
access to cheap manufactures from emerging economies providing steady downward
pressure on prices. But the past few years have provided a less felicitous backdrop. Not only
have we had to deal with the consequences of the financial crisis but we have also had to
manage several major cost shocks. These include: a 25% fall in the sterling effective
exchange rate; fluctuations in the price of oil between $35 and $145 a barrel; and
movements down and up in VAT. Moreover, the impact of these changes has often proved
hard to predict. For instance, we significantly underestimated the pass-through into inflation
of the exchange rate depreciation. So it should not be surprising that inflation has been both
higher and more variable than during the Great Moderation.
The question is: would outcomes have been materially better under an alternative
framework, such as a nominal income target? The first thing to be said is that the idea of
directing macroeconomic policy towards targeting nominal income is by no means new.
James Meade advanced the idea in his 1977 Nobel Prize lecture,2 and my MPC colleague,
Martin Weale, spent much of the early part of his career working with Meade to develop the
idea.3 Samuel Brittan, coming from a slightly different perspective, wrote an important IEA
pamphlet in 1981, which argued that controlling nominal spending was what monetarists
were really seeking to achieve. I even wrote my PhD thesis4 on the topic over thirty years
ago.
There is an important distinction between targeting the level or the growth of nominal income.
The recent revival of academic interest in the issue relates to the scope for a target for the
level of nominal income to provide additional traction for monetary policy when policy rates
reach their zero lower bound. Some of the recent public commentary, however, has centred
on the possible virtues of switching to a target for nominal income growth, so let me deal with
that case first.
In a normal environment, nominal income growth and inflation targets generate similar
responses to aggregate demand shocks. But a nominal income target is more "forgiving"
than a narrowly-defined inflation target in the case of cost shocks. An adverse cost shock
simultaneously tends to raise the price level and reduce output. Stabilising nominal income
requires a one-for-one trade-off in the response, whereas stabilising inflation, or the price
level, requires that all the burden of the shock is transferred onto output. That is the basic
case put forward for the superiority of a nominal income target over a strict inflation target.
This comparison involves something of a straw man, however. As already noted, inflation
targeting as practised, here and elsewhere, allows for an accommodating response to cost
shocks, so long as it is consistent with inflation being stabilised in the medium term. Such
flexible inflation targeting can thus look quite similar to targeting nominal income growth.
This is illustrated by the red line in Chart 1, which shows the four-quarter rate of growth of
nominal income over the lifetime of the MPC. The stability of nominal income growth is
notable - it stays pretty close to 5% with the exception of two periods. First, the Great
Recession of 2008-9, which saw four-quarter nominal GDP growth fall to minus, rather than
plus, 5%. And, second, the past couple of years, when - at least according to the present
vintage of data - nominal GDP growth was nearer 2%-3%.
In neither case, however, was the shortfall by design. The MPC does not presently directly
generate an agreed forecast for nominal income growth, but we can construct a proxy for
such a forecast by combining the MPC's central (mean) projection for GDP growth with its
central (mean) projection for CPI inflation.5 The corresponding one and two year ahead
2
See Meade (1978). James Tobin, another Nobel prize-winner, also advocated adopting a target for nominal
income around the same time (Tobin, 1980). I discuss the relationship between Meade's ideas and inflation
targeting in Bean (2009).
3
See Meade, Vines and Maciejowski (1983) and Weale, Blake, Christodoulakis, Meade and Vines (1989).
4
See Bean (1983). I showed there that nominal GDP targets had good operating properties in the face of
shocks to total factor productivity, as well as to aggregate demand when the main source of nominal frictions
lies in the labour market. Bean (2009) explores the connection between Meade's ideas and modern inflation
targeting.
5
There is reasonably close correspondence between four-quarter nominal GDP growth and the sum of
four-quarter real GDP growth and CPI inflation (over 1993-2012, the correlation coefficient between the two is
0.9 and the average absolute deviation is 0.8 percentage points) which suggests that this is a reasonable
approach.
synthetic forecasts are also shown in Chart 1, denoted by the green and blue lines
respectively. These forecasts are always in the region 4%-5%, with one notable exception,
namely those made during 2009, when the Committee implicitly expected nominal income
growth to recover more slowly than it in practice did. That was because our central
expectation was for markedly lower inflation during 2010 than took place, in large part
because of unexpected increases in energy prices and VAT, together with an unexpectedly
large pass-through from the depreciation.6
So the deviations of nominal income growth from around 5% appear to have been largely
associated with forecast errors. In particular, the collapse in demand after the demise of
Lehman Brothers was so sudden and deep that there was no way that monetary policy could
in practice have been relaxed early enough, and by a large enough amount, to prevent it. It
is, though, a moot point whether policy would have been set even more stimulatory during
the latter part of 2009 if we had been operating under a nominal income growth target, given
that we were implicitly expecting a rather slow recovery in nominal income growth. Given
how stimulatory policy already was, I suspect that we might well have taken the view that it
was simply not feasible to get nominal income growth back much faster.
The unexpected weakness of nominal income growth in the past year or so does, however,
serve to highlight a more significant difference between an inflation target and a nominal
income growth target. A remarkable feature of the current cycle has been the juxtaposition of
a weak recovery in output with robust growth in employment. One possible explanation is
that the financial crisis has led to a fall, possibly temporarily, in the underlying rate of growth
of supply. If that is so, then a fixed nominal income growth target would obviously go
hand-in-hand with a higher inflation rate, whereas a fixed inflation target would be associated
with lower nominal income growth. But this hardly provides an argument in favour of a
nominal income growth target. Indeed, in this case one would surely want to set the target
growth rate for nominal income lower to reflect the lower rate of growth of supply, though by
how much might be hard to judge.
To me, the choice between the present flexible inflation target and a nominal income growth
target - probably also pursued with a degree of flexibility - therefore centres less around any
differences in macroeconomic outcomes, which are likely to be relatively minor, and more
around issues connected with accountability and communication. The issue here is not
whether our objective should include growth - it already does - but whether a target for
nominal income growth provides a better way of describing policy.
One advantage of a nominal income growth target is that it might lead to fewer instances
where we have to resort to the use of our "constrained discretion" to justify a temporary
acceptance of inflation away from the target in order to avoid undue volatility in output and
employment. Fifteen years ago, when the current arrangements were instituted, I calculated7
that inflation should be expected to deviate from the target by more than one percentage
point - thus triggering an Open Letter of explanation to the Chancellor - on about 40% of
occasions. In fact, since 1997, inflation has been more than one percentage point away from
the target, just 20% of the time. But those instances have been entirely concentrated in the
past six years, which has seen inflation varying between 1.1% and 5.2% and averaging
3.1%. As I noted earlier, that reflects the preponderance of adverse cost shocks, which we
have largely accommodated, whether by accident or design. But the concentration of such
shocks runs the risk that the MPC is no longer seen as taking the target seriously. Having a
target in which the acceptable deviations from target are in effect hardwired in might reduce
that risk.
Against that, a nominal income growth target has two drawbacks. The first is that the data for
nominal income is less timely than that for inflation and subject to revision, sometimes
significantly so. Chart 2 shows the first estimate of nominal income growth, together with the
current vintage of data; one should not take comfort from the concordance between the two
series in the recent past, as the recent data have not yet had much opportunity to be revised!
The average absolute revision over 1993-2009 is a full percentage point. Now the
susceptibility to revision is hardly a knock-out blow. After all, the data on growth and
employment are also subject to revision and recognising that the data are an imperfect guide
to reality is part and parcel of setting policy. But the susceptibility of the data to revision
would make it somewhat harder for the public to understand the MPC's objectives and for
Parliament to hold us to account.
The second drawback is that a nominal income growth target would probably mean less to
the average person than does an inflation target. One virtue of an inflation target is it
provides people with a simple heuristic for forming their expectations of how fast prices will
rise. That would be muddied under a nominal income growth target.
The bottom line from all this is that I do not believe that a shift to a nominal income growth
target would represent a major change in the regime. Most of the time, policy settings would
probably be pretty similar. The main consequences would instead lie in how the MPC
explained and justified its decisions.
The same cannot be said of a shift to a target for the level of nominal income, as recently
advocated by Michael Woodford.8 As the incoming Governor of the Bank of England, Mark
Carney, explained in a recent speech,9 such a target would ensure that past control errors
have to be subsequently corrected. Bygones are not bygones, in other words. In the current
context, this is usually taken to mean returning nominal income to a continuation of its
pre-crisis trend line. As Chart 3 reveals, the nominal income shortfall in the United Kingdom
is presently very large - in excess of 15% in fact.
Such history dependence in policy is potentially of value when private agents are sufficiently
forward-looking and the regime is fully credible. For instance, suppose that demand depends
on current and future expected real interest rates, and inflation depends on expected inflation
and the margin of spare capacity in the economy. Now suppose there is an adverse cost
shock that pushes inflation up. One can stabilise inflation by tightening policy sharply but
temporarily. Alternatively one can generate the same disinflationary impact on demand by
tightening policy less aggressively, but maintaining it for longer. And under normal policy
objective functions, the latter course turns out to be preferable because it spreads the burden
of adjustment more evenly over time.
The problem is that such a policy is not time-consistent. The central bank has the incentive to
say that it intends to do this. But once tomorrow comes, it makes sense not to go through
with its promise of holding policy tight, as it suffers a cost in terms of output foregone, while
the benefit has already been gained in the earlier period. It is better simply to renege on the
earlier promise to keep policy tight for a while. Knowing that, private agents will not believe
the central bank's original promise in the first place. So to exploit this "policy-expectations"
channel fully, the central bank needs some way of making its promise credible. The issue of
how such credibility is achieved tends to be ignored in the literature: it is simply assumed that
policy makers can commit themselves - or more often their successors - to behave in the
necessary fashion. But that is rarely possible in practice, other than perhaps a very short
distance ahead.
The difficulty of utilising this particular policy channel is probably not a great issue in normal
times. But it looms larger when policy is constrained by the zero lower bound on interest
rates. In such circumstances - and assuming that alternative policies, such as quantitative
easing, are unavailable or ineffective - an ability to exploit this policy-expectations channel
becomes much more valuable, as the commitment to hold policy loose in the future feeds
back onto aggregate demand today by reducing expected future real interest rates. This
comes about both through a low future nominal interest rate and a higher future rate of
inflation because policy is held "loose for long".
The intent of such a loose-for-long strategy is in some ways similar to quantitative easing, as
both reduce interest rates further down the yield curve. But the former does so by changing
the path of risk-free rates at the near end of the yield curve, while the latter operates mainly
through variations in the term premium further out along the yield curve brought about by
changes in relative asset supplies. Moreover, the loose-for-long approach partly works by
raising future inflation, which is not an objective of quantitative easing.
In order to illustrate the mechanism in operation, I have simulated a small macroeconomic
model of the sort used by Woodford and others to study alternative monetary policies (see
Annex for details). Real demand depends inversely on the current and expected future path
of real interest rates, while the central bank sets the nominal interest rate. Prices in this
economy adjust slowly, with a Phillips-curve relationship linking inflation to the current and
expected future path of slack in the economy. Private agents understand how the economy
works and have rational expectations. The key parameters - the interest elasticity of demand
and the responsiveness of inflation to the output gap - are set to be broadly in line with
empirical evidence for the United Kingdom, but given the extreme simplicity of the model, the
results should be taken as merely illustrative.
In this economy, the slow adjustment of prices in the face of shocks to demand or supply
leads to efficiency losses, which depend on the square of the deviation of inflation from target
and the square of the output gap. The policy maker wishes to minimise the present value of
these efficiency losses. Such an objective can be thought of as describing the rationale for
flexible inflation targeting, namely seeking to stabilise inflation but in a manner that avoids
excessive variability in output.
Chart 4 shows what happens in this economy when there is a large and relatively persistent
drop in demand, but monetary policy is constrained by the zero lower bound on interest
rates. I consider three policy scenarios. In the first scenario (the green line), the central bank
can credibly commit to its future policy settings. I do not regard this as attainable in practice
over anything other than very short time horizons, as central bankers generally cannot tie the
hands of their successors. But it does provide a useful benchmark against which to judge
alternative policies. The nominal interest rate is cut straight to its zero lower bound and
remains there for over six years, far longer than is necessary to bring output back to potential
and enough to generate subsequent overheating and excess inflation. But it is precisely that
expectation of temporarily higher future inflation that reduces expected future real interest
rates and boosts demand today.
In the second scenario (the red line), the central bank cannot commit in this way; the best it
can do is simply to set policy on a quarter by quarter basis. Interest rates are again cut to
their zero lower bound but now the monetary stimulus is withdrawn earlier, after about four
years, and there is no overheating phase. The consequence is that expected real interest
rates are higher than under the first scenario, demand is weaker and the output gap larger.
From a welfare perspective, the first scenario offers a better outcome, because - at least in
the model - the overheating period is a price worth paying to generate higher activity and
less deflation in the near term. But this better outcome is not achievable when the central
bank cannot tie its hands in regards to its future behaviour.
In the third scenario (the blue line), the government gives the central bank the mandate of
stabilising the level of nominal income around a continuation of its pre-shock trend. The
central bank then pursues this different objective, but again on a quarter by quarter basis. In
this case, the output and inflation outcomes lie between the previous two scenarios.10 Giving
the central bank a mandate to target the level of nominal income is, in effect, a way of getting
closer to the first, but unattainable, scenario.
So much for the theory behind a target for the level of nominal income. It is essentially one
way of trying to hardwire in a commitment to maintaining a policy that remains loose long
after conditions have normalised in order to generate the expectation of temporarily higher
inflation in the future. But what may work in an economist's model may not be such a good
idea in the real world. How sensible would it be in practice? And what pitfalls might there be?
First, the simulations show the impact of a pure demand shock resulting in strong deflation
and, given the zero lower bound on the policy rate, also a high real interest rate. That hardly
characterises the UK in the past five years, where inflation has averaged well above our
2% target and the real interest rate has as a consequence been pretty low. Moreover, it is by
no means obvious that the UK's economic problem is simply one of deficient aggregate
demand. The limited disinflationary pressures coupled with consistently weak productivity
growth suggest that the financial crisis may have wrought significant damage to the supply
side of the economy.
Our November Inflation Report discussed a variety of possible explanations for the weakness
in productivity, relative to a continuation of its pre-crisis trend. Some of the weakness may
unwind naturally as the recovery gathers pace, some may require policy intervention to fix,
and some may persist indefinitely. But it seems unwise to assume that all of it will unwind
with a recovery. That part of it which is attributable to a supply-side deterioration will instead
be absorbed as a higher price level under a nominal income target. Of course, this issue
could be addressed by adjusting the target level of nominal income down for the presumed
deterioration in supply, but unfortunately we do not presently have a good handle on just how
big this is. Moreover, it is worth noting that since the MPC's mandate dictates that we should
support growth and employment provided that it does not conflict with achieving the inflation
target, we are in any case charged with seeking to eliminate that part of the shortfall in
nominal demand that is associated with an output gap, or that can be eliminated without
generating inflationary pressure.
Second, hard-wiring in higher inflation for a while is not without risk. In many economic
models - including the one I used earlier - it is only the real interest rate that matters: it is
irrelevant whether a lower real interest rate comes about through a lower nominal interest
rate or a higher inflation rate. In the real world, inflation erodes the real value of cash,
nominal bonds and fixed-interest debts. In itself, that may reduce the impact on demand of
the promise to keep policy loose for long. But it is also apt to breed suspicion of a deliberate
attempt to inflate away debt burdens, and may thus lead to inflation expectations becoming
de-anchored. This is a serious risk: we should not forget the high levels of unemployment in
the 1970s and 1980s associated with bringing inflation expectations back under control.
Third, maintaining low interest rates even after the economy has recovered carries financial
stability risks. My baseline simulations suggest that the period of very loose policy is already
quite extended. But I think there are good reasons for believing that demand may be
presently somewhat less responsive to real interest rates than usual. Uncertainty rose
sharply after the collapse of Lehman Brothers and rose again during the worst of the
euro-area sovereign debt crisis. Banks and highly indebted households and businesses have
focussed on deleveraging and improving the resilience of their balance sheets. Under these
circumstances, it would be hardly surprising if changes in the cost of borrowing have less
traction on demand than is usually the case. Chart 5 shows the implications of assuming the
interest elasticity is just a third of the size assumed in the earlier experiments. The key point
is that the policy rate under a nominal income target is now kept at the zero lower bound for
more than six years, even though the output gap is closed after four. That long period of low
interest rates is necessary to generate enough of a fall in expected future real interest rates
to boost demand today.
But a world where policy is kept loose for so long after the economy is back to normal is
somewhat troubling. The period of low US policy rates during 2004-5 was in part the result of
the FOMC's desire to make good on its earlier promise during the 2001-3 downturn to
maintain low interest rates for a considerable period in order to head off deflation worries.
While I do not believe that the evidence supports the view that this was the sole cause of the
pre-crisis build-up in financial imbalances in the United States, it is plausible that they made
some contribution.11 Maintaining very low interest rates long after the economy has
recovered must run the risk of encouraging a new credit/asset-price boom and the
reappearance of financial imbalances. While macro-prudential policies, such as the
application of the counter-cyclical capital buffer in Basel III, are intended to be the primary
instrument to head off such excesses, it seems unwise to place too great a burden on them.
For that reason, I believe one should be cautious about committing to monetary policies that
remain loose for a very long period after the economy has normalised.
Let me conclude with a few more general remarks about the role of monetary policy at the
current juncture. The sluggishness of the recovery has led some to question whether the
framework is flexible enough to allow for sufficiently expansionary policies to support the
recovery. Conversely, others suggest that the persistent overshoot of the inflation target
indicates that if anything the MPC has interpreted its mandate too flexibly. Given these fears,
I think it is sensible to review the framework to assess whether it is fit for purpose or can be
materially improved, though the hurdle for change should be high.
But there is a danger of expecting too much from monetary policy. The Great Recession of
2008-9 was unlike earlier policy-induced downturns aimed at reining back excessive
inflationary pressures. The period of stability in the decade or so preceding the crisis
encouraged an increasingly relaxed attitude to risk and an excessive build-up of debt,
particularly within the financial system. That was shattered by the cardiac arrest of the global
financial system in the autumn of 2008, resulting in a large downward shock to demand, here
and elsewhere, and the realisation that substantial adjustments to balance sheets were
called for. So it should not be surprising that the recovery since the middle of 2009 has been
so muted.
Monetary policy can - up to a point - play a smoothing role in such circumstances by
encouraging households and businesses to bring forward spending from the future to the
present. And other, more targeted, central bank policies can help unblock dysfunctional
markets or else, as with the Funding for Lending Scheme, support the supply of credit. We
stand ready to take further such action should it be warranted. But such policies cannot -
and should not seek to - prevent the necessary de-leveraging and rebalancing of production
away from non-tradables towards tradables. That is a real process that takes time and
means that the recovery is likely to remain somewhat subdued by historical standards. Thank
you!
Annex
The model used for the simulations is standard in the monetary policy literature and
comprises just two equations. The first is the demand for goods and services (a dynamic IS
curve):
= - - -
xt Etxt+1 (it Ett+1 rt),
where xt is the output gap, t is the deviation of inflation from target (the inflation gap), it is the
nominal policy rate, is the natural real rate of interest, and denotes a rational
rt Et
expectation. This makes the level of demand today a decreasing function of present and
future expected real interest rates. A fall in demand can then be simulated by reducing the
natural real rate of interest, which is then allowed to unwind gradually.
rt,
The second equation describes the supply side and embeds within it an assumption that
prices are sticky (a New Keynesian Phillips Curve):
= +
t Ett+1 xt.
This makes inflation an increasing function of present and future expected output gaps. In
the baseline model,  = 0.6;  = 0.025; and  = .99; in the low interest elasticity variant,  =
0.2.
The loss function that the policy maker wants to minimise takes the form:
2
+ + +..., where = + 2/6.
Vt EtVt+1 2EtVt+2 Vt t xt
Under a nominal GDP target, the above expression for Vt is replaced by:
= -
Vt (yt y*t)2,
where yt is nominal income and y*t is the corresponding target level.
References
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(December), pp. 806-19.
Bean, C.R. (1998). "The new UK monetary arrangements: a view from the literature."
Economic Journal, vol. 108, (November), pp. 1795-1809.
Bean, C.R. (2009). "The meaning of internal balance thirty years on." Economic Journal,
vol. 119, (November), pp. F442-460.
Bean, C.R., Paustian, M., Penalver, A. and Taylor, T. (2011). "Monetary policy after the fall"
in Macroeconomic Challenges: The Decade Ahead, Federal Reserve Bank of Kansas City.
Brittan, S. (1981). "How to end the monetarist controversy." Hobart Paper no. 90, London:
IEA.
Carney, M. (2012). "Guidance." Remarks to CFA Society, Toronto, 11 December, Bank of
Canada.
Meade, J.E. (1978). "The meaning of internal balance." Economic Journal, vol. 88,
(September), pp. 423-35.
Meade, J.E, Vines, D. and Maciejowski J. (1983). Stagflation: Demand Management.
London: Allen & Unwin.
Tobin, J. (1980). "Stabilization policy ten years after." Brookings Papers on Economic
Activity, vol. 11, pp.19-90.
Weale M., Blake A., Christodoulakis N., Meade, J.E and Vines D. (1989). Macroeconomic
Policy: Inflation, Wealth and the Exchange Rate. London: Unwin & Hyman.
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Federal Reserve Bank of Kansas City Symposium, Jackson Hole.
Nominal Income Targets: an Old Wine
in a New Bottle
The State of the Economy
The Institute of Economic Affairs' 30th Conference
Charlie Bean, Deputy Governor Monetary Policy
27 February 2013
Chart 1: Nominal GDP growth
Percentage changes on a year earlier
8
6
4
2
0
-2
Nominal GDP
(a)
Nominal GDP expected 1 year earlier
-4
(a)
Nominal GDP expected 2 years earlier
-6
1999 2001 2003 2005 2007 2009 2011
(a) Sums the Monetary Policy Committee's mean forecasts for real GDP and inflation. The Committee's forecast for RPIX inflation is used prior to
February 2004, adjusted for the difference in the inflation target.
Chart 2: Revisions to nominal GDP growth
Percentage changes on a year earlier
8
6
4
2
0
-2
-4
Initial estimate Latest
-6
-8
1993 1995 1997 1999 2001 2003 2005 2007 2009 2011
Chart 3: Nominal GDP shortfall
Indices: 2008 Q1 = 100
140
130
Nominal GDP
120
Trend
Shortfall
110
100
90
80
70
60
2002 2004 2006 2008 2010 2012
BIS central bankers' speeches 11
Chart 4: Response to a large fall in demand
Output gap Policy rate
Inflation gap
Per cent (annualised)
Per cent (annualised)
Percentage points
2 5.0
5
1 4.5
0
4.0
0
-1 3.5
-2 3.0
-5
-3
2.5
-4
2.0
-10
-5
1.5
-6
1.0
-15
-7
0.5
-8
-20 0.0
1 6 11 16 21 26 31 36 41 46
1 6 11 16 21 26 31 36 41 46
1 6 11 16 21 26 31 36 41 46
Quarters Quarters
Quarters
Inflation Targeting (with Commitment) Inflation Targeting (Discretion) Nominal Income Target
Chart 5: Response to a large fall in demand with a low
interest rate elasticity
Output gap Inflation gap Policy rate
Percentage points Per cent (annualised) Per cent (annualised)
8.0
2 2
0 7.0
0
-2
6.0
-4 -2
5.0
-6
-4 4.0
-8
3.0
-10
-6
2.0
-12
-