central banks ( or what governor mervyn king of the bank of england has termed “ inflation nutters ” ) would give no weight to short - term output considerations in the conduct of monetary policy. most central banks, including the sarb, regard themselves as flexible inflation targeting institutions. by this we mean that there is factored into our decision - making systems concern about what the output costs of our monetary policy actions are going to be. in the jargon of economists, there is some weight on output variability in the bank ’ s objective function. the inflation objective is not discarded, but rather there is a more pragmatic approach to the speed with which inflation is brought back to within the target range. however there is a trade - off between an excessively long period, which would reduce credibility and raise questions about the commitment of the monetary authorities to low inflation, and an excessively short period in which real costs may be high. the rest is judgement for which a central bank must and shall be held accountable. inflation targeting has been an increasingly popular framework since it was first adopted by new zealand in 1990. most studies have shown that it has been a useful framework for assisting in bringing down and maintaining inflation at low levels. currently inflation targeting is probably facing its most severe challenge, as international oil prices have quadrupled since the beginning of 2004, and global food and other commodity prices are experiencing persistent strong increases. whereas a few years ago most countries were within their inflation targets, this unfortunately and regrettably is not the case today. the latest data show that 3 out of 7 industrial countries, and 4 out of 16 emerging market economies are within their targets, although the extent and persistence of the deviation differs somewhat. does this mean that inflation targeting has failed? the true test of the framework will be whether inflation expectations can be sufficiently anchored to weather the current inflationary pressures, and facilitate a return to within the officially set targets. 3. dealing with shocks the nature of the original cost pressures that are facing the economy is well known. these pressures – food and energy – do not appear to be cyclical. this might be a debatable assertion. we are facing a significant and probably a permanent change in relative prices globally. we also have to be concerned about pricing and unit labour cost responses to these relative price changes. if producers simply pass on these increases, and if wages increase to compensate labour for these increases without higher levels of productivity growth, and if we allow this process to take effect

, inflation expectations will deteriorate and generalised inflation will accelerate. we cannot simply sit back idly, the stakes are too high. however, dealing with supply side shocks always poses difficulties for monetary policy makers. the situation we are facing now differs in important respects from the standard case which sees either a shock which is expected to reverse, in which case not much action is required, or a discrete one - off change in relative prices. in the latter more difficult case, the usual response is to look through the inevitable impact on measured inflation, and once this change is through the system, inflation should ideally return to its normal levels. if inflation expectations are firmly entrenched within the inflation target range, then very little response may be required from the monetary authorities, whose main objective under such circumstances would be to ensure that this process does not feed through to more generalised inflation pressures. the challenge, however, is that we are not being faced by a discrete once - off event. rather, we are facing what can best be described as a rolling or continuous shock. international oil prices have been on an upward trend since 2004, apart from some moderation in the latter half of 2006. oil price increases have almost consistently surprised on the upside, requiring a continuous revision of our assumption and thus the forecasts. indications are that food price inflation is expected to continue to remain high for some considerable time. this is most definitely not seen to be a temporary phenomenon. similarly, electricity price increases significantly in excess of the average inflation rate are expected to become a multiyear event, as the process of increasing generating capacity is rolled out. these are unusual developments. unusual responses might be necessary. things, it seems, might get worse before they become better. we are going through bad times. the magnitude of these inflationary pressures has been such that a breach of the target was inevitable. whereas we have to accept that we will be unavoidably outside the target range for longer than we would wish, we are determined to bring cpix inflation back to within the target range within a reasonable time period. if we seem to be abrogating our responsibilities, inflation expectations could get out of hand, price - setting and unit labour costs could become excessive and we could experience an inflation spiral. as noted earlier, we have already seen evidence of second - round effects, deteriorating inflation expectations and elevated wage demands coming through, and these have required a response to prevent inflation getting out of hand. 4. has the monetary