Monetary policy that stabilises

When expected inflation drops, the policy rate should drop even more

The lever of monetary policy can be a force for destabilisation. When the economy faces new difficulties, the forecasted inflation rate declines. If the policy rate does not also commensurately decline, the real rate goes up. When times become hard, and monetary policy does not respond, it makes things worse by raising the real rate. For monetary policy to be a force for good, two features are required. First, the monetary policy committee (MPC) has to be able to peer into the future and forecast inflation. Second, it must respond strongly to changes in forecasted inflation, both on the way