Precautionary Pricing: The Disinflationary Effects of ELB Risk

Authors

Robert Amano

Thomas J. Carter

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2019-26 | October 18, 2019

We construct a model to evaluate the role that the risk of future effective lower bound (ELB) episodes plays as a factor behind the persistently weak inflation witnessed in many advanced economies since the Great Recession. In our model, a range of precautionary channels cause ELB risk to affect inflation and other macroeconomic outcomes even during “normal times” when nominal rates are far away from the ELB. This behavior is enhanced through a growth channel that captures possible long-lasting output declines at the ELB. We show that ELB risk substantially weighs on inflation even when the policy rate is above the ELB. Our model also prwp2019-26edicts substantially below-target inflation expectations and negative inflation risk premia.

About the Authors
Sylvain Leduc is executive vice president and director of Economic Research at the Federal Reserve Bank of San Francisco. Learn more about Sylvain Leduc