Some economists have called for adjusting the inflation target, although in opposite directions: a few have argued for a higher target to avoid testing the Zero Lower Bound often (ZLB); others have called for a lower target, assuming lowflation is the New Normal. In both  2  BIS central bankers’ speeches  cases, hasty changes may only affect the CBs’ credibility and the expectation channel of monetary policy. We have more flexibility on the target horizon. This is the medium term and should not be confused with the 3-year horizon of the forecasts published by the ECB for instance, which may fall short of the target level; what matters is being on a path that is consistent with this medium-term mandate. Forward guidance and the announcement that rates will be “lower for longer” should provide reassurance over the CB’s determination to do “whatever it takes” to fulfill its mandate within this mandate. True, uncertainty about the causes of lowflation and low rates leads to uncertainty over the neutral rate and the need for accommodation; but the more uncertain our environment, the more important and useful it is that we be clear and predictable in order to reduce this uncertainty. According to simulations carried out within the Eurosystem and the BDF, clarifying that the future stance will remain accommodative for many years enhances the efficacy of Quantitative Easing (QE). Third challenge: how effective can non-conventional monetary measures be? The ZLB has proved not to be the effective lower bound.
Spreads and volatility have also been lower for longer, although there is some market discrimination between agents and between emerging market economies (EMEs), as well as periodic spikes in volatility, especially recently. Next, why are inflation or interest rates so low and how does this impact policy? First puzzle: inflation remains low in countries where unemployment is close to the NAIRU, like the USA, or where the output gap has been sharply reduced, like Germany; this may imply that the Phillips curve has a lower slope too. Yet, various studies by the IMF or the BDF show that, even if slopes have tended to flatten since the early 1990s, there has been no clear-cut change over the last years. BIS central bankers’ speeches  1  There are two possible explanations. The benign one is that transitory disinflationary shocks, e.g. due to commodity prices, temporarily shift the Phillips curve downwards. The worrying one would be a disanchoring of long-term inflation expectations, threatening the objective of price stability; such a disanchoring is suggested by the surprising correlation between spot oil prices and market expectations derived from inflation-linked swaps up to 5 years in 5 years. People can reasonably differ in their interpretation; hence the scope for healthy policy debates. As regards low policy or market rates, these are mainly seen as reflecting lower equilibrium, or neutral, interest rates. This leads us to the second puzzle: does the lower neutral interest rate result from cyclical or structural factors?