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Liquidity Traps, Learning and Stagnation

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  • George Evans
  • Eran Guse
  • Seppo Honkapohja

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: https://www.ifw-members.ifw-kiel.de/publications/liquidity-traps-learning-and-stagnation/kap1341.pdf
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Bibliographic Info

Paper provided by Kiel Institute for the World Economy in its series Kiel Working Papers with number 1341.

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Length: 34 pages
Date of creation: Jun 2007
Date of revision:
Handle: RePEc:kie:kieliw:1341

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

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  1. Goodfriend, Marvin, 2000. "Overcoming the Zero Bound on Interest Rate Policy," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 32(4), pages 1007-35, November.
  2. George W. Evans & Seppo Honkapohja, 2002. "Adaptive Learning and Monetary Policy Design," University of Oregon Economics Department Working Papers, University of Oregon Economics Department 2002-18, University of Oregon Economics Department, revised 04 Mar 2004.
  3. Rotemberg, Julio J, 1982. "Sticky Prices in the United States," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 90(6), pages 1187-1211, December.
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  8. George W. Evans & Seppo Honkapohja, 2002. "Monetary Policy, Expectations and Commitment," University of Oregon Economics Department Working Papers, University of Oregon Economics Department 2005-11, University of Oregon Economics Department, revised 06 Apr 2005.
  9. R. Anton Braun & Yuichiro Waki, 2005. "Monetary Policy during Japan's Lost Decade," CIRJE F-Series CIRJE-F-343, CIRJE, Faculty of Economics, University of Tokyo.
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  12. George W. Evans & Seppo Honkapohja & Kaushik Mitra, 2007. "Anticipated Fiscal Policy and Adaptive Learning," University of Oregon Economics Department Working Papers, University of Oregon Economics Department 2007-5, University of Oregon Economics Department, revised 13 Dec 2008.
  13. Lars E.O. Svensson, 2003. "Escaping from a Liquidity Trap and Deflation: The Foolproof Way and Others," Journal of Economic Perspectives, American Economic Association, vol. 17(4), pages 145-166, Fall.
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  15. James Bullard & In-Koo Cho, 2003. "Escapist policy rules," Working Papers 2002-002, Federal Reserve Bank of St. Louis.
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  20. 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.
  21. 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.
  22. Bennett T. McCallum, 2000. "Theoretical analysis regarding a zero lower bound on nominal interest rates," Conference Series ; [Proceedings], Federal Reserve Bank of Boston, pages 870-935.
  23. Preston, Bruce, 2005. "Learning about Monetary Policy Rules when Long-Horizon Expectations Matter," MPRA Paper 830, University Library of Munich, Germany.
  24. George W. Evans & Seppo Honkapohja, 2003. "Policy interaction, expectations, and the liquidity trap," Working Paper, Federal Reserve Bank of Atlanta 2003-16, Federal Reserve Bank of Atlanta.
  25. Laurence Ball, 2005. "Fiscal Remedies for Japan's Slump," NBER Working Papers 11374, National Bureau of Economic Research, Inc.
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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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