The fact that inflation has been running below target in most advanced countries suggests that this challenge is not due to factors specific to a single country. Instead, there are more systemic factors at play, with the root cause being a combination of low neutral interest rates and the lower bound on interest rates. Investors are increasingly viewing these low inflation readings not as an aberration, but rather a new normal. This is evidenced by a broad-based decline in market-based measures of longerrun inflation expectations since the mid-2000s, with the UK providing the exception, as shown in Table 1. This downward slippage of longer-run inflation expectations, if it persists, implies that in the future central banks start further from their inflation goals and have even less room to maneuver, making the problem of low r-star and the ZLB even more difficult. Conclusion The ZLB has been a topic of study for nearly two decades. But recent history and the outlook for the longer-term future, make it more relevant than ever. Low inflation expectations, very low r-star, and slower growth all point to a challenging world where policymakers need to make the best use of the tools at their disposal to achieve their goals of strong economies and price stability. The key lessons from this research hold today and in the future. First, take swift action when faced with adverse economic conditions. Second, keep interest rates lower for longer. And third, adapt monetary policy strategies to succeed in the context of low r-star and the ZLB.
The Global Economic Context Over the past quarter century, a great deal of research has gone into understanding the causes and consequences of the zero lower bound.1 The achievement of low inflation in the United States—which, all else equal, implied lower interest rates—coupled with Japan’s long period of deflation and near-zero interest rates, reignited concern about the ZLB back in the 1990s. And the experience of the global financial crisis and its aftermath—with many advanced economies facing, or in some cases, crossing the zero lower bound—has moved this from a mostly theoretical exercise to a very practical one. An added impetus to this research has been the growing evidence that the neutral rate of interest rate has fallen significantly. I, working with various coauthors, have devoted a significant chunk of my academic career to studying r-star, or the long-run neutral rate of interest, and its implications for monetary policy. Our current estimates of r-star in the United States are around half a percent. That’s actually now lower than at any time before the Great Recession.2 We’ve seen similar declines in r-star in other advanced economies, including in Japan and the euro area. As shown in Figure 1, the weighted average of estimates of r-star for Canada, the euro area, Japan, the United Kingdom, and the United States is now also half a percent, nearly 2 percentage points below where it stood at the turn of this century. These very low neutral rates are a result of long-term structural factors slowing growth.