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Liquidity traps, learning and stagnation

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Author Info

  • Evans, George W.
  • Guse, Eran
  • Honkapohja, Seppo

Abstract

We examine global economic dynamics under learning in a New Keynesian model in which the interest-rate rule is subject to the zero lower bound. Under normal monetary and fiscal policy, the intended steady state is locally but not globally stable. Large pessimistic shocks to expectations can lead to deflationary spirals with falling prices and falling output. To avoid this outcome we recommend augmenting normal policies with aggressive monetary and fiscal policy that guarantee a lower bound on inflation. In contrast, policies geared toward ensuring an output lower bound are insufficient for avoiding deflationary spirals.

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Bibliographic Info

Article provided by Elsevier in its journal European Economic Review.

Volume (Year): 52 (2008)
Issue (Month): 8 (November)
Pages: 1438-1463

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Handle: RePEc:eee:eecrev:v:52:y:2008:i:8:p:1438-1463

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Web page: http://www.elsevier.com/locate/eer

Related research

Keywords: Adaptive learning Monetary policy Fiscal policy Zero interest rate lower bound Indeterminacy;

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References

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  1. Bullard, James & Cho, In-Koo, 2005. "Escapist policy rules," Journal of Economic Dynamics and Control, Elsevier, vol. 29(11), pages 1841-1865, November.
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  8. Gauti Eggertsson & Michael Woodford, 2004. "Optimal monetary and fiscal policy in a liquidity trap," Discussion Papers 0405-02, Columbia University, Department of Economics.
  9. George W. Evans & Seppo Honkapohja, 2004. "Adaptive learning and monetary policy design," Macroeconomics 0405008, EconWPA.
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  13. Jess Benhabib & Stephanie Schmitt-Grohe & Martin Uribe, 1999. "Monetary Policy and Multiple Equilibria," Departmental Working Papers 199914, Rutgers University, Department of Economics.
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  24. Paul R. Krugman, 1998. "It's Baaack: Japan's Slump and the Return of the Liquidity Trap," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 29(2), pages 137-206.
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  1. "Deep Recession Calls for Healthy Dose of Fiscal Stimulation"
    by Mark Thoma in Economist's View on 2009-08-02 20:06:09
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