Monetary Policy and the Drifting Natural Rate of Interest

Empirical analyses find that the long‐run natural rate is subject to permanent shocks. How should monetary policy react to such shocks? Because of the zero lower bound (ZLB) on nominal interest rates, the mere possibility of future movements toward zero of the long‐run natural rate imparts a downward bias on inflation expectations. To offset this bias, a central bank optimizing under commitment should not only rely on forward guidance at the ZLB, as recommended by the existing literature, but also adopt an expansionary bias away from the ZLB.