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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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File URL: http://economics.uoregon.edu/papers/UO-2007-9_Evans_Stagnation.pdf
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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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1285 University of Oregon, 435 PLC, Eugene, OR 97403-1285

Phone: (541) 346-8845
Fax: (541) 346-1243
Web page: http://economics.uoregon.edu/
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  1. Bennett T. McCallum, 2001. "Inflation targeting and the liquidity trap," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  2. Eusepi, Stefano, 2007. "Learnability and monetary policy: A global perspective," Journal of Monetary Economics, Elsevier, vol. 54(4), pages 1115-1131, May.
  3. Bennett T. McCallum, 2000. "Theoretical analysis regarding a zero lower bound on nominal interest rates," Conference Series ; [Proceedings], Federal Reserve Bank of Boston, pages 870-935.
  4. Lars E.O. Svensson, 2003. "Escaping from a Liquidity Trap and Deflation: The Foolproof Way and Others," Journal of Economic Perspectives, American Economic Association, vol. 17(4), pages 145-166, Fall.
  5. George W. Evans & Seppo Honkapohja, 2002. "Monetary Policy, Expectations and Commitment," University of Oregon Economics Department Working Papers 2005-11, University of Oregon Economics Department, revised 06 Apr 2005.
  6. George W. Evans & Seppo Honkapohja, 2004. "Policy interaction, expectations and the liquidity trap," Macroeconomics 0404033, EconWPA.
  7. George W. Evans & Seppo Honkapohja & Kaushik Mitra, 2007. "Anticipated Fiscal Policy and Adaptive Learning," CDMA Working Paper Series 200717, Centre for Dynamic Macroeconomic Analysis.
  8. 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.
  9. Bruce Preston, 2005. "Learning about Monetary Policy Rules when Long-Horizon Expectations Matter," International Journal of Central Banking, International Journal of Central Banking, vol. 1(2), September.
  10. Marvin Goodfriend, 2000. "Overcoming the zero bound on interest rate policy," Conference Series ; [Proceedings], Federal Reserve Bank of Boston, pages 1007-1057.
  11. Benhabib, Jess & Schmitt-Grohé, Stephanie & Uribe, Martín, 1999. "Monetary Policy and Multiple Equilibria," CEPR Discussion Papers 2316, C.E.P.R. Discussion Papers.
  12. 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.
  13. George W. Evans & Seppo Honkapohja, 2003. "Adaptive learning and monetary policy design," Proceedings, Federal Reserve Bank of Cleveland, pages 1045-1084.
  14. Marcet, A. & Nicolini, J.P., 1997. "Recurrent Hyperinflations and Learning," Papers 9721, Centro de Estudios Monetarios Y Financieros-.
  15. 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.
  16. Perri, Fabrizio, 2001. "The role of fiscal policy in Japan: a quantitative study," Japan and the World Economy, Elsevier, vol. 13(4), pages 387-404, December.
  17. R. Anton Braun & Yuichiro Waki, 2006. "Monetary Policy During Japan'S Lost Decade," The Japanese Economic Review, Japanese Economic Association, vol. 57(2), pages 324-344.
  18. Jess Benhabib & Stephanie Schmitt-Grohe & Martin Uribe, 1998. "The perils of Taylor Rules," Departmental Working Papers 199831, Rutgers University, Department of Economics.
  19. 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.
  20. Bullard, James & Cho, In-Koo, 2003. "Escapist policy rules," CFS Working Paper Series 2003/38, Center for Financial Studies (CFS).
  21. 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).
  22. 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.
  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. 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.
  25. Gauti B. Eggertsson & Michael Woodford, 2006. "Optimal Monetary and Fiscal Policy in a Liquidity Trap," NBER Chapters, in: NBER International Seminar on Macroeconomics 2004, pages 75-144 National Bureau of Economic Research, Inc.
  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. 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.
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