Technical Background Document 1: a Brief Review of the Literature on Whether a Low-inflation Regime Leads to Economic Difficulties

Over the last five years, a number of authors have suggested that targeting inflation rates of, say, less than 3 per cent could lead to significant economic difficulties. In the period prior to the renewal of the inflation target, Bank staff have reviewed the literature and have undertaken new research into this issue. The Bank also held a seminar at which papers by both Bank staff and outside academics were presented.1 Our conclusion is that there is no convincing evidence that targeting an inflation range with a midpoint of 2 per cent causes economic problems. Moreover, there is little evidence that an inflation rate of 1 per cent, or perhaps even lower, would cause significant economic problems on an ongoing basis. This document briefly summarizes our review of the recent literature, focusing on arguments related to downward nominalwage rigidity, the inability of interest rates to go below zero, and the potential risk of a costly deflation.