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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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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 6355.

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Date of creation: Jun 2007
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Handle: RePEc:cpr:ceprdp:6355
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  1. 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).
  2. Evans, George W. & Honkapohja, Seppo, 2002. "Monetary policy, expectations and commitment," Working Paper Series 0124, European Central Bank.
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  8. George W. Evans & Seppo Honkapohja, 2004. "Policy interaction, expectations and the liquidity trap," Macroeconomics 0404033, EconWPA.
  9. Bennett McCallum, 2001. "Inflation targeting and the liquidity trap," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  10. Evans, George W. & Honkapohja, Seppo & Marimon, Ramon, 2001. "Convergence In Monetary Inflation Models With Heterogeneous Learning Rules," Macroeconomic Dynamics, Cambridge University Press, vol. 5(01), pages 1-31, February.
  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.
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  13. Bruce Preston, 2003. "Learning about monetary policy rules when long-horizon expectations matter," FRB Atlanta Working Paper No. 2003-18, Federal Reserve Bank of Atlanta.
  14. Laurence M. Ball, 2006. "Fiscal Remedies for Japan's Slump," NBER Chapters, in: Monetary Policy with Very Low Inflation in the Pacific Rim, NBER-EASE, Volume 15, pages 279-306 National Bureau of Economic Research, Inc.
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  19. George W. Evans & Seppo Honkapohja & Kaushik Mitra, 2007. "Anticipated Fiscal Policy and Adaptive Learning," CDMA Working Paper Series 200717, Centre for Dynamic Macroeconomic Analysis.
  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. 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.
  22. Lars E.O. Svensson, 2003. "Escaping from a Liquidity Trap and Deflation: The Foolproof Way and Others," NBER Working Papers 10195, National Bureau of Economic Research, Inc.
  23. 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.
  24. 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.
  25. 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.
  26. 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.
  27. James Bullard & In-Koo Cho, 2003. "Escapist policy rules," Working Papers 2002-002, Federal Reserve Bank of St. Louis.
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