Escaping Secular Stagnation with Unconventional Monetary Policy

We design a new experimental framework to study policy interventions to combat secular stagnations and liquidity traps in an overlapping-generations environment where participants form expectations and make real economic decisions. We observe that participants can learn to coordinate on high inflation full-employment equilibria. Permanent deleveraging shocks induce pessimistic, backward-looking expectations and considerable consumption heterogeneity as the economies experience persistent deflation. We explore the ability of unconventional monetary policy to lead economies out of deflationary traps. Permanently increasing the central bank's inflation target is insufficient to generate inflationary expectations due to low central bank credibility. Negative interest rates stimulate spending and generate the necessary inflation for the economies to escape the zero lower bound. Negative interest rates are more potent than raising the inflation target at shifting consumption to the present.