Issue Falling neutral rates raise the risk of hitting the zero lower bound

Summary

Slower trend growth lowers the real neutral interest rate, which raises the chance that the zero lower bound on nominal rates will bind in future. If expected inflation is also low, nominal rates stay low and the room for rate cuts in a downturn narrows. The authors therefore recommend responding in a balanced way to the risk of too-low inflation as well as the risk of high inflation. Keeping rates high for the sake of financial stability, now an added monetary policy objective, could itself induce low inflation. They call for reviewing which monetary policy framework can preserve financial stability while preventing inflation expectations from falling too far.