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Liquidity Traps, Learning and Stagnation

  • George W. Evans

    ()

    (University of Oregon Economics Department)

  • Eran Guse

    (University of Cambridge)

  • Seppo Honkapohja

    ()

    (University of Cambridge)

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 University of Oregon Economics Department in its series University of Oregon Economics Department Working Papers with number 2007-9.

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Length: 34
Date of creation: 05 Jun 2007
Date of revision: 05 Jun 2007
Handle: RePEc:ore:uoecwp:2007-9
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Web page: http://economics.uoregon.edu/Email:


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  1. George W. Evans & Seppo Honkapohja, 2005. "Policy Interaction, Expectations and the Liquidity Trap," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 8(2), pages 303-323, April.
  2. 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.
  3. Jess Benhabib & Stephanie Schmitt-Grohe & Martin Uribe, 1998. "The perils of Taylor Rules," Departmental Working Papers 199831, Rutgers University, Department of Economics.
  4. Jess Benhabib & Stephanie Schmitt-Grohe & Martin Uribe, 1999. "Monetary Policy and Multiple Equilibria," Departmental Working Papers 199914, Rutgers University, Department of Economics.
  5. Fabrizio Perri, 1999. "The Role of Fiscal Policy in Japan: A Quantitative Study," Working Papers 99-16, New York University, Leonard N. Stern School of Business, Department of Economics.
  6. 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.
  7. George W. Evans & Seppo Honkapohja, 2003. "Adaptive learning and monetary policy design," Proceedings, Federal Reserve Bank of Cleveland, pages 1045-1084.
  8. Bennett T. McCallum, 2001. "Inflation Targeting and the Liquidity Trap," Working Papers Central Bank of Chile 112, Central Bank of Chile.
  9. Coenen Günter & Orphanides Athanasios & Wieland Volker, 2004. "Price Stability and Monetary Policy Effectiveness when Nominal Interest Rates are Bounded at Zero," The B.E. Journal of Macroeconomics, De Gruyter, vol. 4(1), pages 1-25, February.
  10. Bruce Preston, 2003. "Learning about monetary policy rules when long-horizon expectations matter," Working Paper 2003-18, Federal Reserve Bank of Atlanta.
  11. Bennett T. McCallum, 2000. "Theoretical Analysis Regarding a Zero Lower Bound on Nominal Interest Rates," NBER Working Papers 7677, National Bureau of Economic Research, Inc.
  12. Klaus Adam & Roberto M. Billi, 2005. "Discretionary monetary policy and the zero lower bound on nominal interest rates," Research Working Paper RWP 05-08, Federal Reserve Bank of Kansas City.
  13. Gauti B. Eggertsson & Michael Woodford, 2004. "Optimal Monetary and Fiscal Policy in a Liquidity Trap," NBER Working Papers 10840, National Bureau of Economic Research, Inc.
  14. Goodfriend, Marvin, 2000. "Overcoming the Zero Bound on Interest Rate Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 32(4), pages 1007-35, November.
  15. Eusepi, Stefano, 2007. "Learnability and monetary policy: A global perspective," Journal of Monetary Economics, Elsevier, vol. 54(4), pages 1115-1131, May.
  16. Bullard, James & Cho, In-Koo, 2003. "Escapist policy rules," CFS Working Paper Series 2003/38, Center for Financial Studies (CFS).
  17. Laurence Ball, 2005. "Fiscal Remedies for Japan's Slump," NBER Working Papers 11374, National Bureau of Economic Research, Inc.
  18. 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.
  19. 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.
  20. Marcet, A. & Nicolini, J.P., 1997. "Recurrent Hyperinflations and Learning," Papers 9721, Centro de Estudios Monetarios Y Financieros-.
  21. Evans, George W. & Honkapohja, Seppo & Mitra, Kaushik, 2009. "Anticipated fiscal policy and adaptive learning," Journal of Monetary Economics, Elsevier, vol. 56(7), pages 930-953, October.
  22. Evans, George W. & Honkapohja, Seppo & Marimon, Ramon, 1996. "Convergence in Monetary Inflation Models with Heterogeneous Learning Rules," CEPR Discussion Papers 1310, C.E.P.R. Discussion Papers.
  23. 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.
  24. Kenneth N. Kuttner & Adam S. Posen, 2002. "Passive Savers and Fiscal Policy Effectiveness in Japan," Working Paper Series WP02-2, Peterson Institute for International Economics.
  25. George W. Evans & Seppo Honkapohja, 2006. "Monetary Policy, Expectations and Commitment," Scandinavian Journal of Economics, Wiley Blackwell, vol. 108(1), pages 15-38, 03.
  26. Kuttner, Kenneth N. & Posen, Adam S., 2002. "Fiscal Policy Effectiveness in Japan," Journal of the Japanese and International Economies, Elsevier, vol. 16(4), pages 536-558, December.
  27. 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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