Policy Interaction, Expectations and the Liquidity Trap
AbstractWe consider inflation and government debt dynamics when monetary policy employs a global interest rate rule and private agents forecast using adaptive learning. Because of the zero lower bound on interest rates, active interest rate rules are known to imply the existence of a second, low inflation steady state, below the target inflation rate. Under adaptive learning dynamics we find the additional possibility of a liquidity trap, in which the economy slips below this low inflation steady state and is driven to an even lower inflation floor that is supported by a switch to an aggressive money supply rule. Fiscal policy alone cannot push the economy out of the liquidity trap. However, raising the threshold at which the money supply rule is employed can dislodge the economy from the liquidity trap and ensure a return to the target equilibrium.
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Bibliographic InfoPaper provided by University of Oregon Economics Department in its series University of Oregon Economics Department Working Papers with number 2003-33.
Date of creation: 30 Apr 2003
Date of revision: 06 Jul 2004
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Other versions of this item:
- George W. Evans & Seppo Honkapohja, 2005. "Policy Interaction, Expectations and the Liquidity Trap," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 8(2), pages 303-323, April.
- Evans, George W. & Honkapohja , Seppo, 2003. "Policy interaction, expectations and the liquidity trap," Research Discussion Papers 22/2003, Bank of Finland.
- George W. Evans & Seppo Honkapohja, 2003. "Policy interaction, expectations, and the liquidity trap," Working Paper 2003-16, Federal Reserve Bank of Atlanta.
- George W. Evans & Seppo Honkapohja, 2004. "Policy interaction, expectations and the liquidity trap," Macroeconomics 0404033, EconWPA.
- E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy
- E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
- E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
This paper has been announced in the following NEP Reports:
- NEP-ALL-2003-10-28 (All new papers)
- NEP-MAC-2003-10-28 (Macroeconomics)
- NEP-MON-2003-10-28 (Monetary Economics)
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