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Expectations, deflation traps and macroeconomic policy

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Author Info

  • Evans , George W

    (University of Oregon, University of St. Andrews)

  • Honkapohja, Seppo

    ()
    (Bank of Finland)

Abstract

We examine global economic dynamics under infinite-horizon learning in a New Keynesian model in which the interest-rate rule is subject to the zero lower bound. As in Evans, Guse and Honkapohja, European Economic Review (2008), we find that under normal monetary and fiscal policy the intended steady state is locally but not globally stable. Unstable deflationary paths can arise after large pessimistic shocks to expectations. For large expectation shocks that push interest rates to the zero lower bound, temporary increases in government spending can effectively insulate the economy from deflation traps.

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File URL: http://www.suomenpankki.fi/en/julkaisut/tutkimukset/keskustelualoitteet/Documents/0924netti.pdf
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Bibliographic Info

Paper provided by Bank of Finland in its series Research Discussion Papers with number 24/2009.

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Length: 35 pages
Date of creation: 22 Sep 2009
Date of revision:
Handle: RePEc:hhs:bofrdp:2009_024

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Postal: Bank of Finland, P.O. Box 160, FI-00101 Helsinki, Finland
Web page: http://www.suomenpankki.fi/en/
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Keywords: adaptive learning; monetary policy; fiscal policy; zero interest rate lower bound;

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  1. Coenen, Günter & Orphanides, Athanasios & Wieland, Volker, 2003. "Price stability and monetary policy effectiveness when nominal interest rates are bounded at zero," CFS Working Paper Series 2003/13, Center for Financial Studies (CFS).
  2. Bruce Preston, 2003. "Learning about monetary policy rules when long-horizon expectations matter," Working Paper 2003-18, Federal Reserve Bank of Atlanta.
  3. George W. Evans & Eran Guse & Seppo Honkapohja, 2007. "Liquidity Traps, Learning and Stagnation," University of Oregon Economics Department Working Papers 2007-9, University of Oregon Economics Department, revised 05 Jun 2007.
  4. Stefano Eusepi & Bruce Preston, 2007. "Central Bank Communication and Expectations Stabilization," NBER Working Papers 13259, National Bureau of Economic Research, Inc.
  5. Klaus Adam & Roberto M. Billi, 2005. "Discretionary monetary policy and the zero lower bound on nominal interest rates," Research Working Paper RWP 05-08, Federal Reserve Bank of Kansas City.
  6. Leeper, Eric M., 1991. "Equilibria under 'active' and 'passive' monetary and fiscal policies," Journal of Monetary Economics, Elsevier, vol. 27(1), pages 129-147, February.
  7. Preston, Bruce, 2006. "Adaptive learning, forecast-based instrument rules and monetary policy," Journal of Monetary Economics, Elsevier, vol. 53(3), pages 507-535, April.
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