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Liquidity Traps, Learning and Stagnation

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Author Info

  • George W. Evans

    ()
    (University of Oregon Economics Department)

  • Eran Guse

    (University of Cambridge)

  • Seppo Honkapohja

    ()
    (University of Cambridge)

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: http://economics.uoregon.edu/papers/UO-2007-9_Evans_Stagnation.pdf
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Bibliographic Info

Paper provided by University of Oregon Economics Department in its series University of Oregon Economics Department Working Papers with number 2007-9.

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Length: 34
Date of creation: 05 Jun 2007
Date of revision: 05 Jun 2007
Handle: RePEc:ore:uoecwp:2007-9

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Postal: 1285 University of Oregon, 435 PLC, Eugene, OR 97403-1285
Phone: (541) 346-4661
Fax: (541) 346-1243
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Web page: http://economics.uoregon.edu/
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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. George W. Evans & Seppo Honkapohja, 2006. "Monetary Policy, Expectations and Commitment," Scandinavian Journal of Economics, Wiley Blackwell, vol. 108(1), pages 15-38, 03.
  2. Bruce Preston, 2005. "Learning about Monetary Policy Rules when Long-Horizon Expectations Matter," International Journal of Central Banking, International Journal of Central Banking, vol. 1(2), September.
  3. 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.
  4. Goodfriend, Marvin, 2000. "Overcoming the Zero Bound on Interest Rate Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 32(4), pages 1007-35, November.
  5. George W. Evans & Seppo Honkapohja & Kaushik Mitra, 2007. "Anticipated Fiscal Policy and Adaptive Learning," CDMA Working Paper Series 200717, Centre for Dynamic Macroeconomic Analysis.
  6. Albert Marcet & Juan P. Nicolini, 1995. "Recurrent hyperinflations and learning," Economics Working Papers 244, Department of Economics and Business, Universitat Pompeu Fabra, revised Nov 2001.
  7. 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.
  8. Benhabib, Jess & Schmitt-Grohe, Stephanie & Uribe, Martin, 2001. "The Perils of Taylor Rules," Journal of Economic Theory, Elsevier, vol. 96(1-2), pages 40-69, January.
  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.
  10. Rotemberg, Julio J, 1982. "Sticky Prices in the United States," Journal of Political Economy, University of Chicago Press, vol. 90(6), pages 1187-1211, December.
  11. 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.
  12. Coenen Günter & Orphanides Athanasios & Wieland Volker, 2004. "Price Stability and Monetary Policy Effectiveness when Nominal Interest Rates are Bounded at Zero," The B.E. Journal of Macroeconomics, De Gruyter, vol. 4(1), pages 1-25, February.
  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.
  14. 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.
  15. 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.
  16. Evans, George W. & Honkapohja , Seppo, 2003. "Policy interaction, expectations and the liquidity trap," Research Discussion Papers 22/2003, Bank of Finland.
  17. Laurence M. Ball, 2006. "Fiscal Remedies for Japan’s Slump," NBER Chapters, in: Monetary Policy under Very Low Inflation in the Pacific Rim, NBER-EASE, Volume 15, pages 279-306 National Bureau of Economic Research, Inc.
  18. 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.
  19. Benhabib, J. & Schmitt-Grohe, S. & Uribe, M., 1998. "Monetary Policy and Multiple Equilibria," Working Papers 98-02, C.V. Starr Center for Applied Economics, New York University.
  20. Kuttner, Kenneth N. & Posen, Adam S., 2002. "Fiscal Policy Effectiveness in Japan," Journal of the Japanese and International Economies, Elsevier, vol. 16(4), pages 536-558, December.
  21. Perri, F., 1999. "The Role of Fiscal Policy in Japan: a Quantitative Study," New York University, Leonard N. Stern School Finance Department Working Paper Seires 99-16, New York University, Leonard N. Stern School of Business-.
  22. Gauti B. Eggertsson & Michael Woodford, 2004. "Optimal Monetary and Fiscal Policy in a Liquidity Trap," NBER Working Papers 10840, National Bureau of Economic Research, Inc.
  23. Bullard, James & Cho, In-Koo, 2003. "Escapist policy rules," CFS Working Paper Series 2003/38, Center for Financial Studies (CFS).
  24. 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.
  25. Eusepi, Stefano, 2007. "Learnability and monetary policy: A global perspective," Journal of Monetary Economics, Elsevier, vol. 54(4), pages 1115-1131, May.
  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.
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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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