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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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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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References

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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," Working Paper Series, European Central Bank 0231, European Central Bank.
  2. Eusepi, Stefano, 2007. "Learnability and monetary policy: A global perspective," Journal of Monetary Economics, Elsevier, Elsevier, vol. 54(4), pages 1115-1131, May.
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  6. George W. Evans & Seppo Honkapohja, 2002. "Monetary Policy, Expectations and Commitment," University of Oregon Economics Department Working Papers, University of Oregon Economics Department 2002-11, University of Oregon Economics Department, revised 01 Feb 2004.
  7. Benhabib, J. & Schmitt-Grohe, S. & Uribe, M., 1998. "Monetary Policy and Multiple Equilibria," Working Papers, C.V. Starr Center for Applied Economics, New York University 98-02, C.V. Starr Center for Applied Economics, New York University.
  8. George W. Evans & Seppo Honkapohja, 2003. "Adaptive learning and monetary policy design," Proceedings, Federal Reserve Bank of Cleveland, Federal Reserve Bank of Cleveland, pages 1045-1084.
  9. Marvin Goodfriend, 2000. "Overcoming the zero bound on interest rate policy," Working Paper, Federal Reserve Bank of Richmond 00-03, Federal Reserve Bank of Richmond.
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  12. Marcet, Albert & Nicolini, Juan Pablo, 1998. "Recurrent Hyperinflations and Learning," CEPR Discussion Papers, C.E.P.R. Discussion Papers 1875, C.E.P.R. Discussion Papers.
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  14. 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.
  15. Adam, Klaus & Billi, Roberto M., 2005. "Discretionary monetary policy and the zero lower bound on nominal interest rates," CFS Working Paper Series 2005/16, Center for Financial Studies (CFS).
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  21. Gauti B. Eggertsson & Michael Woodford, 2003. "The Zero Bound on Interest Rates and Optimal Monetary Policy," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 34(1), pages 139-235.
  22. 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.
  23. Evans, George W. & Honkapohja, Seppo & Marimon, Ramon, 2001. "Convergence In Monetary Inflation Models With Heterogeneous Learning Rules," Macroeconomic Dynamics, Cambridge University Press, Cambridge University Press, vol. 5(01), pages 1-31, February.
  24. Kenneth N. Kuttner & Adam S. Posen, 2002. "Passive Savers and Fiscal Policy Effectiveness in Japan," Working Paper Series, Peterson Institute for International Economics WP02-2, Peterson Institute for International Economics.
  25. Lars E.O. Svensson, 2003. "Escaping from a Liquidity Trap and Deflation: The Foolproof Way and Others," Journal of Economic Perspectives, American Economic Association, American Economic Association, vol. 17(4), pages 145-166, Fall.
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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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