There are two ways to reduce the risk of too low inflation and inflation expectations. Firstly, by having a clear and genuinely symmetric definition of price stability, and secondly, by having a reaction function that delivers sufficiently forceful and equally effective policy actions to deviations from the target to both directions.
In this year’s Presidential Address to the American Economic Association, Ben Bernanke maintained that if the neutral rate is below 2% or so, the new tools will add valuable policy space but are unlikely to compensate entirely for the constraint imposed by the lower bound.3 He also added that the costs associated with a very low neutral rate, measured in terms of deeper and longer recessions and inflation staying persistently below target, underscore the importance for the central banks of keeping inflation and inflation expectations close to the target.