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Liquidity traps, learning and stagnation

  • Evans, George W.
  • Guse, Eran
  • Honkapohja, Seppo

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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Article provided by Elsevier in its journal European Economic Review.

Volume (Year): 52 (2008)
Issue (Month): 8 (November)
Pages: 1438-1463

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Handle: RePEc:eee:eecrev:v:52:y:2008:i:8:p:1438-1463
Contact details of provider: Web page: http://www.elsevier.com/locate/eer

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  4. Evans, G.W. & Honkapohja ,S. & Mitra, K., 2007. "Anticipated Fiscal Policy and Adaptive Learning," Cambridge Working Papers in Economics 0705, Faculty of Economics, University of Cambridge.
  5. Evans, George W. & Honkapohja, Seppo, 2002. "Adaptive learning and monetary policy design," Research Discussion Papers 29/2002, Bank of Finland.
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  9. 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.
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