It is an honor to participate in this conference to mark the retirement of Mervyn King from the Bank of England and to thank him for his long public service. I am particularly grateful to Mervyn for his sensible ideas and practical approaches to policy over the years, and especially for our collaborations dealing with the economic aftermath of the 9/11 attacks when I was at the U.S. Treasury from 2001-2005. I will never forget his kindness—such as inviting me to play in a tennis match at Wimbledon with Alan Greenspan and me playing against him and Gus O’Donnell—or his competitive spirit, especially after I took a terrible spill going for one of his drop shots in that match.
Charlie Bean asked that we begin with some “provocative opening remarks” to encourage a lively discussion. In light of the occasion, my starting point will be Mervyn King’s Stamp Memorial Lecture given last October at the London School of Economics. In that lecture, Mervyn reviewed—in his usually clear and systematic way—monetary policy and economic performance leading up to, during, and after the financial crisis. He helpfully reflected on some of his own decisions as made then with information then available in real time. His goal was to draw lessons for monetary policy in the future. See King (2012).
Mervyn organized his thinking in the Stamp Lecture around the policy tradeoff between inflation stability and output stability. The following figure shows the tradeoff exactly as 2 depicted in his lecture (in Figure 5). The variance of inflation is on the vertical axis and the variance of output is on the horizontal axis. Points that are higher or further out represent poorer macroeconomic performance. The tradeoff frontier between the two is implied and can be calculated from dynamic macroeconomic models which incorporate some degree of price and wage rigidity, forward looking behavior, and stochastic shocks.
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