The third reason why lambda may vary over time is that the transmission mechanism of monetary policy has evolved with the changing nature of the financial sector, the openness of the economy, and the indebtedness of households. Moreover, the tools in the monetary arsenal have expanded since the crisis, including large-scale asset purchases whose transmission is less well understood than conventional measures. When such uncertainties are particularly high, it is natural to take them into account when setting monetary policy. That can motivate setting monetary policy in a cautious way,  24  favouring gradualism. In effect, this adds a  desire for interest rate stability to the monetary loss function, which has the effect of reducing the relative weight on output stabilisation. Fourth, given the primacy of price stability in the Bank’s monetary policy remit, the credibility of the monetary framework is paramount. This MPC carefully reviews household, business, and financial markets’ expectations regarding future inflation. Any perceived risks to medium-term inflation expectations could justify more concerted efforts to return inflation to the target than usual, and therefore lower lambda. Fifth, the role of unknowns in the economic outlook may be so prominent that they don’t constitute risks, but “radical uncertainties”. 25  These are uncertainties that are at once powerful and profound, yet impossible to  quantify over the monetary policy horizon, even with subjective probabilities. Such uncertainties do not fit neatly into the “linear-quadratic” approach to policy which embeds certainty equivalence and sets policy with regard to the mean outcome for the economy.

The remit recognises that inflation may deviate temporarily from the target on account of shocks, however. Since 2013, the remit has explicitly recognised that in these circumstances, bringing inflation back to target too rapidly could cause volatility in output and employment that is undesirable. The remit requires the MPC to consider, balance and explain such short-run monetary policy trade-offs. Specifically, in exceptional circumstances, “shocks to the economy may be particularly large or the effects of shocks may persist over an extended period or both”. When this is the case, the challenge facing the MPC can be more significant, and the remits directs that “[i]n forming and communicating its judgements, the Committee should promote understanding of the trade-offs inherent in setting monetary policy”, including, importantly “the horizon over which the Committee judges it is appropriate to return inflation to the target”. 2. Achieving price stability A simple framework for thinking about how to manage the monetary policy trade-off is shown in Figure 1. The red line in the figure illustrates a policymaker’s preferred trade-off: mapping the size of the shortfall of output below potential – the output gap – that the policymaker is prepared to tolerate for a given overshoot of inflation from target, and vice versa. The flatter the line the less the weight the policymaker places on output stabilisation and the more they are willing to tolerate large output gaps in order to eliminate small overshoots in inflation.