From a monetary policy perspective, this means that the equilibrium real interest rate – defined as the value of the short-term real interest rate consistent with the economy operating at its potential (or sustainable) level and inflation at its objective – has declined.5 Faced with disinflationary shocks, a central bank wishing to preserve price stability when the equilibrium real rate has declined has to steer interest rates to levels below the equilibrium real rate prevailing in the long run.
Yet, while the equilibrium real rate can be very negative, there is a lower bound to the nominal interest rate. In the context of the disinflationary pressures we faced in 2014 and 2015, this implied that the room for the additional reduction of short-term interest rates was insufficient to generate the necessary stimulus, given the low level of the equilibrium rate.