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Expectations, Stagnation and Fiscal Policy

Author

Listed:
  • Seppo Honkapohja

    (Bank of Finland)

  • Kaushik Mitra

    (University of Birmingham)

  • George Evans

    (University of Oregon)

Abstract

Persistent stagnation and fiscal policy are examined in a New Keynesian model with adaptive learning determining expectations. We impose inflation and consumption lower bounds, which can be relevant when agents are pessimistic. The inflation target is locally but not globally stable under learning. Pessimistic initial expectations may sink the economy into steady-state stagnation with deflation. The deflation rate can be near zero for discount factors near one or if credit frictions are present. Following a severe pessimistic expectations shock a large temporary fiscal stimulus is needed to avoid or emerge from stagnation. A modest stimulus is sufficient if implemented early.

Suggested Citation

  • Seppo Honkapohja & Kaushik Mitra & George Evans, 2017. "Expectations, Stagnation and Fiscal Policy," 2017 Meeting Papers 160, Society for Economic Dynamics.
  • Handle: RePEc:red:sed017:160
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    References listed on IDEAS

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    Cited by:

    1. Gibbs, Christopher G., 2018. "Learning to believe in secular stagnation," Economics Letters, Elsevier, vol. 163(C), pages 50-54.
    2. Lansing, Kevin J., 2017. "Endogenous Regime Switching Near the Zero Lower Bound," Working Paper Series 2017-24, Federal Reserve Bank of San Francisco.

    More about this item

    JEL classification:

    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy

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