through, in a disciplined way, what might happen if inflation expectations were to become dislodged. but, so far, they do not do much to help us know what to look for in identifying whether inflation expectations are in the process of becoming dislodged. we do not know enough about how households and firms form their expectations – how much forward7 looking, how much backward - looking – to be able to model the process rigorously. that is not part of the ‘ information set ’ of policymakers in today ’ s world. what this underlines is that policymakers may well not be able to rely on their models to help them terribly much when the stakes are highest ; ie when our credibility may be fragile. they are tools to help us think. but they don ’ t tell us the answers. crucially, we have to make judgments about whether medium - term inflation expectations are, in fact, securely anchored. we need to resist falling into the trap of thinking that the nominal side is now, and forever, nicely looked after by some miracle of credibility. for example, ‘ treasury committee questionnaire ahead of appointment hearing for mr paul tucker ’, the monetary policy committee of the bank of england : appointment hearing, first report of session 2005 - 06, volume ii. erceg c. j. and a. t. levin, 2003, ‘ imperfect credibility and inflation persistence ’, journal of monetary economics, 2003, vol. 50, issue 4. notwithstanding the extent to which analysis of real economic variables seems to dominate the pages of most central banks ’ published analysis, including the bank of england ’ s, maintaining real aggregate demand in line with supply is not a sufficient condition for achieving an inflation target ; indeed, it would be consistent with any level of inflation. we absolutely have to attend to indicators of medium - term nominal trends. that is why central bankers like me look at measures of inflation expectations from as many sources as we can : bond markets, surveys etc. and it is why the ecb and others, including at the bank of england, track the monetary aggregates as a cross check, a potential amber light alerting us to medium - term risks. stabilisation policy and the impracticalities of fine tuning : real - side stuff that brings me to the second element in the conduct of policy : stabilisation of the path of demand and output, in order to keep inflation in line with the target over the cycle, to underline the

interest rate lever. in a rational world, the result was no permanent increase in jobs but a higher - than - desired steady - state rate of inflation. and the solutions variously offered by the academy included appointing a ‘ conservative central banker ’ more averse to inflation than society at large, or writing a ‘ contract ’ that incentivises the monetary authority to do the right thing 25. in practice, the solution has amounted to a combination of central bank independence, clear goals, and transparency. these real - world central bankers care about ensuring that nominal magnitudes do not distort economic decision taking, and they care about their reputations. but they are not ‘ conservative ’ in the sense of being ‘ inflation nutters ’. rather they are ‘ dutiful ’ in the sense of sticking to a clear, symmetric mandate. that, many would argue, has been a necessary condition for achieving credibility. but now it is argued that a monetary authority does, after all, still have an incentive to cheat. this time, not on its delivery of price stability in line with a target over the medium - to - long run, but rather in how it stabilizes shorter - run fluctuations in demand and inflation in the face of shocks. as i understand it, broadly the argument runs as follows. assume that a shock to costs hits the economy ; the oil price rise over the past couple of years might be the kind of thing. in the short - run, demand and output will be pushed below the economy ’ s ‘ trend ’ path, and inflation above the authority ’ s target. in the story, to bring inflation back to target, the central bank raises its policy rate and announces that it will keep it higher for a while. because it is believed, near - term inflation expectations drop back in line with the target. that being so, in order to avoid ‘ lost ’ output, it is now optimal for the central bank to reduce its policy rate back to where it was, ie not to leave it higher. the central bank has therefore not done what it said it would do ; it has been time inconsistent. and, reflecting rational / model - consistent expectations, agents allow for this, so that central bank stabilisation policy is not as potent as it could be if credible commitments were feasible. for this practitioner at least, the story does not sound very much like reality. unlike the inflation problems of the past, it is not obvious to me that we are going about breaking promises about