THE Bank of England released its quarterly inflation report this morning. It also published the letter from Mark Carney, governor of the bank, to George Osborne, Britain's chancellor of the exchequer, that was required to explain why inflation—currently 0.5%—had deviated more than a percentage point below the bank's target of 2%. According to the report's forecasts, inflation will turn negative in the coming months as a result of the huge fall in oil prices. However, the letter emphasises the short-term, one-off nature of the oil-price shock, which will fall out of the numbers relatively quickly and so requires no offsetting action. Mr Carney noted that in 68% of the categories which make up the CPI, prices are rising. In any case, the bank thinks it takes 18-24 months for monetary policy to have an impact on the economy; the oil-price fall came on much more quickly.

When asked whether the bank was overlooking the oil-price decline because it was unanticipated or because it was external to the economy, Mr Carney said it was the former. Were the bank able to forecast supply shocks in time to offset them, it would have to do so under its inflation-targeting mandate ("If we knew it, and could lean against it, we would"). Mr Carney hinted that in such a situation, it might be worth reconsidering the mandate.

That's one of the problems with inflation-targeting regimes. The central bank uses its interest rate to steer demand. Demand shocks cause output and inflation to move in the same direction; if demand rises, both output and inflation tend to go up too. But a positive supply shock—like the recent fall in oil prices—increases output while supressing inflation. To offset the deflationary effect of a "good" supply shock, the bank would have to lower interest rates to stimulate the domestic economy. That is, the bank would have to let the economy overheat. In the event of a negative supply-shock, such as an oil-price rise, the bank would have to slow down the domestic economy—potentially causing unemployment—in order to generate domestic deflationary pressure. The overall effect is to increase the volatility of domestic output, rather than promote macroeconomic stability, one of the intentions behind inflation targeting.

As has been frequently pointed out in the blogosphere, if the bank targeted nominal GDP (NGDP) rather than inflation, there would be no such problem. Under a such a regime, the bank would concern itself only with nominal spending in the economy, which can rise due to inflation or due to output growth (the supply-side of the economy determines the split between the two). The bank could therefore tolerate supply-side shocks which boosted growth and reduced inflation, as they would have an offsetting effect on NGDP. There would be no need to manipulate domestic output to offset forces from abroad.

In another interesting revelation, the bank said it no longer thinks the interest rate—currently 0.5%—is at its lower bound. Previously, it felt unable to cut rates below 0.5% due to concerns about financial stability. In particular, low interest rates pose a threat to building societies, institutions which are almost entirely funded by deposits and whose assets are mainly mortgage lending. Rates on deposits cannot fall below zero—lest savers withdraw their money—but a cut in bank rate would reduce interest payments on flexible-rate mortgages. This would squeeze the margins of building societies, potentially eroding their capital base and threatening their viability. The bank reckons that building societies now have sufficient capital to survive a margin squeeze from another rate cut.

That could prove useful. A big negative demand shock—caused by, say, Greece leaving the euro and tipping the euro zone into chaos—can now be offset by more than just quantitative easing. That will please sceptics of unconventional monetary policy.