Taylor details BOE's Optimal Policy Projections for inflation
Bank of England's Alan Taylor explained how the Monetary Policy Committee (MPC) uses Optimal Policy Projections (OPPs) to manage trade-offs between inflation and output stability. These model-based simulations help identify optimal policy paths to achieve price stability.
Balancing inflation and output stability
The Monetary Policy Committee's (MPC) remit requires maintaining 2% CPI inflation, but acknowledges temporary deviations due to shocks.
Since 2013, the remit explicitly allows for managing trade-offs, recognizing that rapidly returning inflation to target could cause undesirable volatility in output and employment.
This flexible inflation targeting approach is rooted in the Phillips Curve, which describes the positive relationship between inflation and the output gap.
Monetary policy can address inflation by compressing output, which is effective for demand shocks.
However, supply or cost-push shocks can move inflation and output in opposite directions, creating a crucial trade-off that the MPC must balance and explain.
Simulating optimal policy paths
Bank of England staff produce Optimal Policy Projections (OPPs) during MPC forecast preparation to explore this policy problem.
These model-based simulations aim to identify the best outcomes for inflation and the output gap, along with the policy path to achieve them.
OPPs take the MPC's forecast as given and assume it is known and believed by all.
However, OPPs are not a perfect guide; they abstract from real-world considerations like uncertainty, time variation in the monetary transmission mechanism, and interactions with other policymakers.
They are a highly conditional exercise, exploring policy adjustments relative to the market curve.
A useful, imperfect compass
While not a perfect guide, the OPPs offer a valuable analytical lens for the MPC, illustrating trade-offs and potential rate paths.
Their utility lies in informing discussions and communications, providing an additional perspective alongside standard forecasts.
Ultimately, these projections serve as a sophisticated tool for understanding complex policy dilemmas, despite their inherent reliance on strong assumptions.