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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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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 6355.

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Date of creation: Jun 2007
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Handle: RePEc:cpr:ceprdp:6355

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Keywords: adaptive learning; fiscal policy; indeterminacy; monetary policy; zero interest rate lower bound;

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References

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  1. Gauti Eggertsson & Michael Woodford, 2004. "Optimal monetary and fiscal policy in a liquidity trap," Discussion Papers 0405-02, Columbia University, Department of Economics.
  2. Evans, George W & Honkapohja, Seppo & Mitra, Kaushik, 2007. "Anticipated Fiscal Policy and Adaptive Learning," CEPR Discussion Papers 6216, C.E.P.R. Discussion Papers.
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  5. Evans, George W. & Honkapohja , Seppo, 2003. "Policy interaction, expectations and the liquidity trap," Research Discussion Papers 22/2003, Bank of Finland.
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  13. George W. Evans & Seppo Honkapohja, 2002. "Adaptive Learning and Monetary Policy Design," University of Oregon Economics Department Working Papers 2002-18, University of Oregon Economics Department, revised 04 Mar 2004.
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  20. Fabrizio Perri, 1999. "The Role of Fiscal Policy in Japan: A Quantitative Study," Working Papers 99-16, New York University, Leonard N. Stern School of Business, Department of Economics.
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  22. Evans, George W & Honkapohja, Seppo & Marimon, Ramon, 1996. "Convergence in Monetary Inflation Models with Heterogeneous Learning Rules," CEPR Discussion Papers 1310, C.E.P.R. Discussion Papers.
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  25. Adam, Klaus & Billi, Roberto M., 2007. "Discretionary monetary policy and the zero lower bound on nominal interest rates," Journal of Monetary Economics, Elsevier, vol. 54(3), pages 728-752, April.
  26. Kenneth N. Kuttner & Adam S. Posen, 2002. "Passive Savers and Fiscal Policy Effectiveness in Japan," Working Paper Series WP02-2, Peterson Institute for International Economics.
  27. 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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