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Policy Effects in a Simple Fully Non-Linear New Keynesian Model of the Liquidity Trap

Author

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  • Volker Hahn

    () (Department of Economics, University of Konstanz, Germany)

Abstract

We analyze a simple yet fully non-linear New Keynesian model with a central bank that pursues an inflation targeting strategy. Our analysis shows that expected adverse productivity shocks may drive the economy into a liquidity trap. As our model entails positive or moderately negative inflation in such a situation, it has the potential to explain the so-called “missing disinflation” in the Great Recession. In contrast with some previous papers, we find that the effects of fiscal policy in a liquidity trap are moderate and that reductions in labor income taxes are expansionary. We do not find support for higher inflation targets. Finally, we provide additional support for the view that the common practice of log-linearizing equilibrium relations can be potentially misleading in models with a lower bound on nominal interest rates.

Suggested Citation

  • Volker Hahn, 2017. "Policy Effects in a Simple Fully Non-Linear New Keynesian Model of the Liquidity Trap," Working Paper Series of the Department of Economics, University of Konstanz 2017-05, Department of Economics, University of Konstanz.
  • Handle: RePEc:knz:dpteco:1705
    as

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    File URL: http://www.uni-konstanz.de/FuF/wiwi/workingpaperseries/WP_05_Hahn_2017.pdf
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    References listed on IDEAS

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    More about this item

    Keywords

    Zero lower bound; missing disinflation; fiscal multiplier; liquidity trap; new Keynesian model; multiple equilibria; inflation target;

    JEL classification:

    • 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
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy

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