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Liquidity traps, learning and stagnation

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  • 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

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

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References

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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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