. federalreserve. gov / monetarypolicy / files / fomc _ longerrungoals. pdf. real interest rates are not constrained by the zero bound, and the fact that expected average real short - term interest rates are near zero reflects that the nominal rate is expected, on average, to run close to the expected inflation rate, which is near 2 percent. bis central bankers ’ speeches accommodative policy for some time : most recently, the fomc indicated that it expects to maintain an exceptionally low level of the federal funds rate at least as long as the unemployment rate is above 6. 5 percent, projected inflation between one and two years ahead is no more than a half percentage point above the committee ’ s 2 percent target, and long - term inflation expectations remain stable. 5 in discussing the role of monetary policy in determining the expected future path of real short - term rates, i have cheated a little : what monetary policy actually controls is nominal short - term rates. however, because inflation adjusts slowly, control of nominal short - term rates usually translates into control of real short - term rates over the short and medium term. in the longer term, real interest rates are determined primarily by nonmonetary factors, such as the expected return to capital investments, which in turn is closely related to the underlying strength of the economy. the fact that market yields currently incorporate an expectation of very low short - term real interest rates over the next 10 years suggests that market participants anticipate persistently slow growth and, consequently, low real returns to investment. in other words, the low level of expected real short rates may reflect not only investor expectations for a slow cyclical recovery but also some downgrading of longer - term growth prospects. 6 chart 3, which displays yields on inflation - indexed, long - term government bonds for the same five countries represented in chart 1, shows that expected real yields over the longer term are low in other advanced industrial economies as well. note again the strong similarity in returns across these economies, suggesting once again the importance of common global factors. while indexed yields spiked up around the end of 2008, reflecting market stresses at the height of the crisis that undercut the demand for these bonds, these effects dissipated in 2009. since that time, inflation - indexed yields have declined steadily and now stand below zero in each country. 7 apparently, low longer - term real rate expectations are playing an important role in accounting for low 10 -

long - term rate could also again force the fed to pump money out to a highly inflationary degree. the difference is all in the way the macroeconomy works. the straightforward way to resolve this impasse is to try to explain it to politicians who remain skeptical. as evidence, one could use the 1960s and 1970s as dramatic indications of what happens when macro policy violates the natural unemployment rate rule and the equilibrium interest rate rule, with rather dire subsequent inflationary consequences. or the 1990s could be used as an illustration of how monetary policy could lower inflation, with concomitant gains in terms of full employment and long - term economic growth. similar conversations might have occurred in all those countries where the government seems to have eagerly adopted inflation targeting. but these attempts to explain inflation targeting still might not work, and the congress might still delineate specific unemployment and interest rate goals along with inflation goals. were such to be the case, particularly if the specific goals for unemployment or interest rates were set inappropriately, as was done in the humphrey - hawkins act of the late 1970s, i believe that even die - hard advocates of inflation targeting would consider the costs greater than the benefits. given the already good inflation performance in the united states, the benefits of adopting inflation targeting are likely to be modest. but in an inappropriately constrained system, the costs could be enormous. another potential political cost of inflation targeting involves loss of flexibility. as inflation targeting has evolved in other countries, and in the thinking of academic economists, a flexible approach to inflation targeting has proved quite popular. specific goals for inflation are important, yes, but not under any and all circumstances. real - world economies are subject to unanticipated shocks and unanticipated financial crises. sometimes monetary authorities, even under inflation targeting, must respond to these shocks by going outside the price stability band for a short period. for example, the ecb has held its short - term interest rate at a low level for a significant period even though inflation has been slightly above its target ceiling most of that time. many outside observers believe that economic sluggishness is the real problem in europe and are quite sympathetic with the ecb strategy, even though it may violate a strict interpretation of inflation targeting. most experts and others interested in inflation targeting understand this need for flexibility and are quite comfortable with flexible inflation - targeting schemes. in all likelihood, any scheme designed for the united states would feature such flexibility. so far there is no