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Expectations, Deflation Traps and Macroeconomic Policy

  • George W. Evans

    ()

    (University of Oregon Economics Department and University of St. Andrews)

  • Seppo Honkapohja

    ()

    (Bank of Finland, Helsinki, Finland)

We examine global economic dynamics under infinite-horizon learning in a New Keynesian model in which the interest-rate rule is subject to the zero lower bound. As in Evans, Guse and Honkapohja (2008), we find that under normal monetary and fiscal policy the intended steady state is locally but not globally stable. Unstable deflationary paths can arise after large pessimistic shocks to expectations. For large expectation shocks pushing interest rates to the zero lower bound, temporary increases in government spending can be used to insulate the economy from deflation traps.

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Paper provided by University of Oregon Economics Department in its series University of Oregon Economics Department Working Papers with number 2010-5.

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Length: 32
Date of creation: 06 Jul 2010
Date of revision:
Handle: RePEc:ore:uoecwp:2010-5
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  1. Evans, George W. & Guse, Eran & Honkapohja, Seppo, 2008. "Liquidity traps, learning and stagnation," European Economic Review, Elsevier, vol. 52(8), pages 1438-1463, November.
  2. 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.
  3. Preston, Bruce, 2006. "Adaptive learning, forecast-based instrument rules and monetary policy," Journal of Monetary Economics, Elsevier, vol. 53(3), pages 507-535, April.
  4. Coenen, Günter & Orphanides, Athanasios & Wieland, Volker, 2003. "Price Stability and Monetary Policy Effectiveness when Nominal Interest Rates are Bounded at Zero," CEPR Discussion Papers 3892, C.E.P.R. Discussion Papers.
  5. Bruce Preston, 2003. "Learning about monetary policy rules when long-horizon expectations matter," Working Paper 2003-18, Federal Reserve Bank of Atlanta.
  6. Stefano Eusepi & Bruce Preston, 2007. "Central Bank Communication and Expectations Stabilization," Discussion Papers 0708-10, Columbia University, Department of Economics.
  7. 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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