When a central bank reduces interest rates, it limits its ability to provide further stimulus going forward. Given there is a lower bound on the cash rate, the decision to cut rates today means one more cut that cannot be delivered in the future, should economic conditions worsen.
In effect, by using policy flexibility today, policy makers, with a finite number of ways to deliver stimulus, reduce their future flexibility to loosen policy. We have developed the Policy Inflexibility Index to model the degree of policy choices that support growth and inflation expectations, in any given country, in a systematic way.
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