2  BIS Review 29/2004  enough, the economy could even be pushed into a deflationary spiral, in which price falls accelerate. Although monetary policy in such a situation still disposes of other instruments, the reduction of nominal interest rates will have reached its limits at the zero bound. The real interest rate would therefore increase with deflation.
If, on the other hand, the central bank’s target in the medium term is not zero inflation, but rather a low, positive rate of price increases, the nominal interest rate will, with a given real equilibrium interest rate, also rise. That provides greater scope for reacting to negative demand shocks by means of interest rate reductions.