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Liquidity Traps, Learning and Stagnation

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  • Evans, G.W.
  • Guse, E.
  • Honkapohja, S

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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File URL: http://www.econ.cam.ac.uk/research/repec/cam/pdf/cwpe0732.pdf
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Bibliographic Info

Paper provided by Faculty of Economics, University of Cambridge in its series Cambridge Working Papers in Economics with number 0732.

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Length: 29
Date of creation: Jun 2007
Date of revision:
Handle: RePEc:cam:camdae:0732

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Web page: http://www.econ.cam.ac.uk/index.htm

Related research

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

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References

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  3. George W. Evans & Seppo Honkapohja, 2003. "Policy Interaction, Expectations and the Liquidity Trap," University of Oregon Economics Department Working Papers 2003-33, University of Oregon Economics Department, revised 06 Jul 2004.
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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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