that monetary policy operates against an everchanging backdrop of ideas about the way the economy works, a theme that lies at the heart of my lecture. first, it is now widely accepted that there is no long - run trade - off between output and inflation. both theory – following friedman and phelps – and practice – particularly in the 1970s – showed that permanently higher inflation does not bring faster growth or higher employment, and may well reduce both. but in the post - war period views were different. in 1959 the radcliffe report on the workings of the monetary system seemed to support the idea of a permanent trade - off. the objectives of monetary policy included, it argued, “ a high and stable level of employment ” and “ reasonably stability of the internal purchasing power of money ”. but it went on, “ … there are serious possibilities of conflict between them. ” 4 second, the rate of inflation in the long run is determined by monetary policy, not by microeconomic factors. again, that is now taken for granted, but much effort was devoted to the imposition of detailed direct wage and price controls in the 1960s and 1970s. nicholas kaldor, adviser to harold wilson, wrote in 1971 that “ it is also far more generally acknowledged – even by conservative prime ministers – that the process of inflation is'cost - induced'and not demand - induced ', with the evident implication that it can be tackled only by an incomes policy'”. not many whitehall advisers would give that answer today. third, in the short run monetary policy does affect output and employment and so has the potential to be an effective stabilisation tool. reflecting a post - war consensus that monetary policy was rather ineffective, however, the radcliffe report concluded that “ …. there can be no reliance on this weapon [ interest rate policy ] as a major short - term stabiliser of demand ” 5 it is now accepted that monetary policy lies at the heart of any attempt to stabilise the economy. the source of monetary policy ’ s influence over output and employment lies in frictions, which mean that prices and wages do not adjust instantaneously to clear markets whenever demand and supply are out of balance. firms change prices only irregularly in response to changes in demand ; wages adjust only slowly as labour market conditions alter ; and expectations are updated only slowly as new information is received. such frictions generate short - run relationships between money, activity and inflation. 6 the nature of frictions goes right to the heart of

). the published rpix series starts in 1976. for observations before 1976, the allitems rpi was used. the rpi series before 1976 did not include mortgage interest payments. table 2 : the persistence of inflation 1950 - 2005 persistence 1950 - 59 0. 5 1960 - 69 0. 3 1970 - 79 0. 7 1980 - 92 0. 8 1993 - 2005 0. 2 source : ons and bank of england calculations. note : persistence in this table is the sum of the coefficients on lagged inflation in a regression of quarterly inflation on a constant and 4 lags. the measure of inflation is rpi before 1976 and rpix from 1976, seasonally adjusted. chart 4 : catching a cricket ball ball a f chart 5 : the variability of expected future interest rates, us and uk basis points us uk source : bank of england calculations. note : variability is calculated as the standard deviation of daily changes in the ten year instantaneous nominal forward rate over a yearly window. chart 6 : the variability of inflation and output, 1955 - 2004 standard de viation of inflation, pe r cent a 1970 - 1979 1980 - 1992 1955 - 1959 a 1960 - 1969 1993 - 2004 standard de viation of gdp growth, pe r cent source : ons and bank of england calculations. note : standard deviation of inflation is calculated from quarterly observations of annual inflation ; standard deviation of output growth is calculated using annualised quarterly observations of output growth.