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Policy Interaction, Expectations and the Liquidity Trap

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  • George W. Evans

    (University of Oregon)

  • Seppo Honkapohja

    (University of Helsinki)

Abstract

We consider inflation and debt dynamics under a global interest rate rule when private agents forecast using adaptive learning. Given the zero lower bound on interest rates, active interest rate rules are known to imply the existence of a second, low-inflation steady state. Under learning the economy can slip below this low-inflation steady state and be driven to an even lower inflation floor supported by a switch to an aggressive money supply rule. Fiscal policy alone cannot push the economy out of this liquidity trap. Raising the inflation floor sufficiently can ensure a return to the target equilibrium. (Copyright: Elsevier)

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File URL: http://dx.doi.org/10.1016/j.red.2005.01.002
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Bibliographic Info

Article provided by Elsevier for the Society for Economic Dynamics in its journal Review of Economic Dynamics.

Volume (Year): 8 (2005)
Issue (Month): 2 (April)
Pages: 303-323

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Handle: RePEc:red:issued:v:8:y:2005:i:2:p:303-323

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Related research

Keywords: Adaptive Learning; Monetary Policy; Fiscal Policy; Zero Interest Rate Lower Bound; Indeterminacy;

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  1. Evans, George W & Honkapohja, Seppo, 1995. "Local Convergence of Recursive Learning to Steady States and Cycles in Stochastic Nonlinear Models," Econometrica, Econometric Society, Econometric Society, vol. 63(1), pages 195-206, January.
  2. Thomas Sargent & Noah Williams & Tao Zha, 2006. "The Conquest of South American Inflation," NBER Working Papers 12606, National Bureau of Economic Research, Inc.
  3. In-Koo Cho & Kenneth Kasa, 2003. "Learning Dynamics and Endogenous Currency Crises," Computing in Economics and Finance 2003, Society for Computational Economics 132, Society for Computational Economics.
  4. Cho, In-Koo & Williams, Noah & Sargent, Thomas J, 2002. "Escaping Nash Inflation," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 69(1), pages 1-40, January.
  5. Benhabib, Jess & Schmitt-Grohe, Stephanie & Uribe, Martin, 1998. "The Perils of Taylor Rules," Working Papers, C.V. Starr Center for Applied Economics, New York University 98-37, C.V. Starr Center for Applied Economics, New York University.
  6. Jess Benhabib & Stephanie Schmitt-Grohe & Martin Uribe, 2000. "Avoiding Liquidity Traps," Departmental Working Papers, Rutgers University, Department of Economics 199925, Rutgers University, Department of Economics.
  7. N. Williams, 2002. "Stability and Long Run Equilibrium in Stochastic Fictitious Play," Princeton Economic Theory Working Papers, David K. Levine cbeeeb49cc8afc83f125df5a8, David K. Levine.
  8. Bullard, James & Cho, In-Koo, 2003. "Escapist policy rules," CFS Working Paper Series, Center for Financial Studies (CFS) 2003/38, Center for Financial Studies (CFS).
  9. William Poole, 2002. "Flation," Speech, Federal Reserve Bank of St. Louis 49, Federal Reserve Bank of St. Louis.
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  1. > Macroeconomics > Monetary Theory
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