This paper explores issues that arise in implementing monetary policy under conditions of
sustained price stability. We discuss several issues that concern the selection of a central
bank's inflation objective under such conditions: price measurement; the behavior of other key
variables, particularly wages; and the possible existence of other channels through which
low inflation could change relationships within the real economy. We present a framework for
analyzing monetary policy reaction functions that can illuminate the choices facing policy makers
in a regime of price stability. The zero lower bound on nominal interest rates is a potential
constraint on monetary policy when nominal interest rates are low on average, which will tend to
be the case when long-term inflation is low. We summarize the results of research done at the
Federal Reserve to clarify these issues for the United States and consider the availability and
effectiveness of alternative policy tools when the nominal interest rate is at the zero bound.
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Last update: July 19, 2001