However, a symmetric PLT regime—in which misses have to be made up on both sides of the inflation objective—has an important shortcoming. Compensating for inflation overshoots by deliberately keeping inflation below the FOMC’s 2 percent objective would increase the risk of getting pinned at the effective lower bound for interest rates. As a consequence, some—including former Chairman Ben Bernanke—have proposed adopting an asymmetric PLT regime. In such a system, misses below the objective would be offset by misses above only when the effective lower bound was binding. Under normal circumstances, misses above the objective would not be offset. Rather, they would be treated as “bygones,” as is currently the case.14 However, I suspect that establishing a modified PLT regime would present some challenges. First, for such a modified PLT to be effective in anchoring inflation expectations, households and businesses would have to understand how the regime would work, and view the Federal 5/7  BIS central bankers' speeches  Reserve’s commitment as credible. One can imagine that such credibility might be hard to sustain during a long spell of inflation misses to the downside. Second, while such a regime might be attractive in broad brush form, the devil lies in the details. If inflation undershot for a few years, what would the desired overshoot path look like? How high would the FOMC permit inflation to go above its objective, and for how long? What would happen if the Fed failed to fully offset past downside misses and cumulative undershoots became sizable?
For example, if we are in a period of “secular stagnation”— characterized by chronic excess global savings and aging populations—then one would expect r* to remain persistently low. 3 But, if we are in a world of abating headwinds as we recover from the financial crisis, then one would expect r* to rise over time. This lack of clarity about the environment increases the degree of uncertainty about the level of r*. Despite all these uncertainties, one still has to have a viewpoint. In the current circumstances, I would judge that r* over the medium term is likely to be somewhere around 1 percent. Although that is higher than the estimates from some models, I have nudged up my estimate because financial conditions are still easy and fiscal policy will likely be quite stimulative in 2018 and 2019.4 If the neutral real interest rate is around 1 percent, there is still some distance to go before monetary policy actually gets tight. At the FOMC’s 2 percent inflation objective, my estimate of r* implies that the federal funds rate would need to rise to around 3 percent for monetary policy to be considered neutral. Of course, as the factors that influence r* change, my estimate of r* will also move around over time. 2/7  BIS central bankers' speeches  Whether monetary policy will need to move to a restrictive setting depends crucially on how low the unemployment rate can go without inflation climbing meaningfully above 2 percent.