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Macroeconomic dynamics near the ZLB: a tale of two equilibria

  • S. Boragan Aruoba
  • Frank Schorfheide

This paper studies the dynamics of a New Keynesian dynamic stochastic general equilibrium (DSGE) model near the zero lower bound (ZLB) on nominal interest rates. In addition to the standard targeted-inflation equilibrium, we consider a deflation equilibrium as well as a Markov sunspot equilibrium that switches between a targeted-inflation and a deflation regime. We use the particle filter to estimate the state of the U.S. economy during and after the 2008-09 recession under the assumptions that the U.S. economy has been in either the targeted-inflation or the sunspot equilibrium. We consider a combination of fiscal policy (calibrated to the American Recovery and Reinvestment Act) and monetary policy (that tries to keep interest rates near zero) and compute government spending multipliers. Ex-ante multipliers (cumulative over one year) under the targeted-inflation regime are around 0.9. A monetary policy that keeps interest rates at zero can raise the multiplier to 1.7. The ex-post (conditioning on the realized shocks in 2009-11) multiplier is estimated to be 1.3. Conditional on the sunspot equilibrium, the multipliers are generally smaller and the scope for conventional expansionary monetary policy is severely limited.

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Paper provided by Federal Reserve Bank of Philadelphia in its series Working Papers with number 13-29.

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Date of creation: 2013
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Handle: RePEc:fip:fedpwp:13-29
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  1. Lawrence Christiano & Martin Eichenbaum & Sergio Rebelo, 2011. "When Is the Government Spending Multiplier Large?," Journal of Political Economy, University of Chicago Press, vol. 119(1), pages 78 - 121.
  2. Marco Del Negro & Frank Schorfheide, 2012. "DSGE model-based forecasting," Staff Reports 554, Federal Reserve Bank of New York.
  3. Christopher J. Gust & J. David Lopez-Salido & Matthew E. Smith, 2012. "The empirical implications of the interest-rate lower bound," Finance and Economics Discussion Series 2012-83, Board of Governors of the Federal Reserve System (U.S.).
  4. Peter N. Ireland, 2001. "Money's Role in the Monetary Business Cycle," NBER Working Papers 8115, National Bureau of Economic Research, Inc.
  5. Braun, R Anton & Koerber, Lena & Waki, Yuichiro, 2015. "Some Unpleasant Properties of Loglinearized Solutions When the Nominal Rate is Zero," Bank of England working papers 553, Bank of England.
  6. Jesús Fernández-Villaverde & Grey Gordon & Pablo Guerrón-Quintana & Juan F. Rubio-Ramírez, 2012. "Nonlinear adventures at the zero lower bound," Working Papers 12-10, Federal Reserve Bank of Philadelphia.
  7. Kenneth L. Judd & Lilia Maliar & Serguei Maliar, 2010. "A Cluster-Grid Projection Method: Solving Problems with High Dimensionality," NBER Working Papers 15965, National Bureau of Economic Research, Inc.
  8. Mertens, Karel & Ravn, Morten O, 2010. "Fiscal Policy in an Expectations Driven Liquidity Trap," CEPR Discussion Papers 7931, C.E.P.R. Discussion Papers.
  9. Tim Hursey & Alexander L. Wolman, 2010. "Monetary policy and global equilibria in a production economy," Economic Quarterly, Federal Reserve Bank of Richmond, issue 4Q, pages 317-337.
  10. Judd, Kenneth L., 1992. "Projection methods for solving aggregate growth models," Journal of Economic Theory, Elsevier, vol. 58(2), pages 410-452, December.
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