Kohn, Donald

The last item on my list of limitations was that simple rules do not take account of risk-management considerations.  As shown in Figure 2A, the core CPI inflation rate for 2003 was falling toward 1 percent.  The real-time reading of the core PCE inflation rate (not shown) was on average even lower than the comparable CPI figure.  Given these rates, the possibility of deflation could not be ruled out.  We had carefully analyzed the Japanese experience of the early 1990s; our conclusion was that aggressively moving against the risk of deflation would pay dividends by reducing the odds on needing to deal with the zero bound on nominal interest rates should the economy be hit with another negative shock.  This factor is not captured by simple policy rules.