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Policy Interaction, Expectations and the Liquidity Trap

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Author Info
George W. Evans (University of Oregon)
Seppo Honkapohja (University of Helsinki)

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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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Publisher 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;

Other versions of this item:

Find related papers by JEL classification:
E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

References listed on IDEAS
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  1. In-Koo Cho & Kenneth Kasa, 2003. "Learning Dynamics and Endogenous Currency Crises," Computing in Economics and Finance 2003 132, Society for Computational Economics. [Downloadable!]
    Other versions:
  2. Thomas Sargent & Noah Williams & Tao Zha, 2006. "The Conquest of South American Inflation," NBER Working Papers 12606, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  3. Bullard, James & Cho, In-Koo, 2005. "Escapist policy rules," Journal of Economic Dynamics and Control, Elsevier, vol. 29(11), pages 1841-1865, November. [Downloadable!] (restricted)
    Other versions:
  4. Evans, George W & Honkapohja, Seppo, 1995. "Local Convergence of Recursive Learning to Steady States and Cycles in Stochastic Nonlinear Models," Econometrica, Econometric Society, vol. 63(1), pages 195-206, January. [Downloadable!] (restricted)
  5. Cho, In-Koo & Williams, Noah & Sargent, Thomas J, 2002. "Escaping Nash Inflation," Review of Economic Studies, Blackwell Publishing, vol. 69(1), pages 1-40, January.
    Other versions:
  6. Benhabib, Jess & Schmitt-Grohe, Stephanie & Uribe, Martin, 2001. "The Perils of Taylor Rules," Journal of Economic Theory, Elsevier, vol. 96(1-2), pages 40-69, January. [Downloadable!] (restricted)
    Other versions:
  7. Jess Benhabib & Stephanie Schmitt-Grohe & Martin Uribe, 2002. "Avoiding Liquidity Traps," Journal of Political Economy, University of Chicago Press, vol. 110(3), pages 535-563, June. [Downloadable!] (restricted)
    Other versions:
  8. N. Williams, 2002. "Stability and Long Run Equilibrium in Stochastic Fictitious Play," Princeton Economic Theory Working Papers cbeeeb49cc8afc83f125df5a8, David K. Levine. [Downloadable!]
Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Adam, Klaus & Billi, Roberto M, 2003. "Optimal Monetary Policy Under Commitment with a Zero Bound on Nominal Interest Rates," CEPR Discussion Papers 4111, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
  2. James B. Bullard, 2006. "The learnability criterion and monetary policy," Review, Federal Reserve Bank of St. Louis, issue May, pages 203-217. [Downloadable!]
  3. George Evans & Eran Guse & Seppo Honkapohja, 2007. "Liquidity Traps, Learning and Stagnation," Kiel Working Papers 1341, Kiel Institute for the World Economy. [Downloadable!]
    Other versions:
  4. repec:bep:maccon:v:6:y:2006:i:1:p:1437-1437 is not listed on IDEAS
  5. James Bullard & In-Koo Cho, 2003. "Escapist policy rules," Working Papers 2002-002, Federal Reserve Bank of St. Louis. [Downloadable!]
    Other versions:
  6. Evans, George W & Honkapohja, Seppo, 2008. "Expectations, Learning and Monetary Policy: An Overview of Recent Rersearch," CEPR Discussion Papers 6640, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
  7. Orlando Gomes, . "Volatility, Heterogeneous Agents and Chaos," The Electronic Journal of Evolutionary Modeling and Economic Dynamics, IFReDE - Université Montesquieu Bordeaux IV. [Downloadable!]
    Other versions:
  8. Wiliam Branch & George W. Evans, 2005. "A Simple Recursive Forecasting Model," University of Oregon Economics Department Working Papers 2005-3, University of Oregon Economics Department, revised 01 Feb 2005. [Downloadable!]
    Other versions:
  9. Kauko, Karlo, 2003. "Interlinking securities settlement systems: A strategic commitment?," Research Discussion Papers 26/2003, Bank of Finland. [Downloadable!]
  10. Ragna Alstadheim & Dale W. Henderson, 2004. "Price-level determinacy, lower bounds on the nominal interest rate, and liquidity traps," International Finance Discussion Papers 795, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
    Other versions:
  11. Vauhkonen, Jukka, 2003. "Are adverse selection models of debt robust to changes in market structure?," Research Discussion Papers 28/2003, Bank of Finland. [Downloadable!]
  12. Stefano Eusepi & Bruce Preston, 2008. "Stabilizing expectations under monetary and fiscal policy coordination," Staff Reports 343, Federal Reserve Bank of New York. [Downloadable!]
    Other versions:
  13. Stefano Eusepi, 2008. "Central bank transparency and nonlinear learning dynamics," Staff Reports 342, Federal Reserve Bank of New York. [Downloadable!]
  14. Ronald B. Davies & Paul Shea, 2003. "Adaptive Learning with a Unit Root: An Application to the Current Account," University of Oregon Economics Department Working Papers 2006-15, University of Oregon Economics Department, revised 10 Jun 2003. [Downloadable!]
  15. Todd E. Clark & Michael W. McCracken, 2006. "Forecasting of small macroeconomic VARs in the presence of instabilities," Research Working Paper RWP 06-09, Federal Reserve Bank of Kansas City. [Downloadable!]
  16. Loisel, O., 2006. "Bubble-free interest-rate rules," Documents de Travail 161, Banque de France. [Downloadable!]
  17. George W. Evans & Seppo Honkapohja, 2008. "Learning and Macroeconomics," University of Oregon Economics Department Working Papers 2008-3, University of Oregon Economics Department. [Downloadable!]
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This page was last updated on 2009-11-20.

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