As I see things, the Fed's inflation target-and especially the asymmetric way in which it appears to worry about overshooting relative to undershooting-is the key constraint. And I'm inclined to think that it would not because key measures of inflation are not substantially below 2% and falling. If the Fed's target interest rate were well above zero right now, would the Fed announce a rate cut today? I'm inclined to think that it would not. To answer the question of whether the ZLB is a binding technical constraint, we just need to think on this paragraph's opening sentence. Mr Krugman goes on to explain that the Fed has other tools available but has opted not to deploy them to the extent that it should have. The tool the Fed usually fights recessions with had reached the limits of its usefulness. In other words, the Fed hit what’s known in economic jargon as the zero lower bound (or, alternatively, became stuck in a liquidity trap). Investors won’t buy bonds if they can get a better return simply by putting a bunch of $100 bills in a safe. And that was as far as the Fed could go, because (some narrow technical exceptions aside) interest rates can’t go lower. When the recession began in 2007, the Fed started slashing short-term interest rates until November 2008, when they bottomed out near zero, where they remain to this day.
The problem is that rates can’t be cut further. Right now, the Fed believes that it’s facing a weak economy and subdued inflation, a situation in which it would ordinarily cut interest rates. I also think his piece helps illustrate why the zero lower bound is not at all a binding technical constraint. I agree with much of what Mr Krugman has to say about the differences in the views of Mr Bernanke the chairman compared with Mr Bernanke the professor. If the Fed does stand pat, expect Mr Bernanke to take some tough questions from attending journalists, motivated by a big new Paul Krugman essay criticising the chairman for failing to do more to address unemployment. Hopes for new stimulative action by the Fed are low, despite some disconcerting recent data points. THE Federal Open Market Committee will conclude its two-day April meeting today, and Chairman Ben Bernanke will give a press conference this afternoon.