The Role of Nonlinearity in Indeterminate Models: An Application to Expectations-Driven Liquidity Traps

Yoichiro Tamanyu

No 2020-023, Keio-IES Discussion Paper Series from Institute for Economics Studies, Keio University

Abstract: This paper proposes a novel methodology to derive nonlinear solutions of an indeterminate DSGE model in which the decision rules are affected by sunspot shocks. We apply the method to an expectations-driven liquidity trap---a liquidity trap that arises because of the zero lower bound constraint on the nominal interest rate and the de-anchoring of economic agents' expectations---and find that the model dynamics exhibit significant nonlinearity. Such nonlinearity arises because the zero lower bound ceases to bind once the inflation rate rises because of a temporary increase in inflation expectations.

Keywords: Indeterminacy; Nonlinearity; Sunspot; Expectations-Driven Liquidity Traps; Zero Lower Bound (search for similar items in EconPapers)
JEL-codes: C62 C63 E31 (search for similar items in EconPapers)
Pages: 34 pages
Date: 2020-11-28
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-mon
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Persistent link: https://EconPapers.repec.org/RePEc:keo:dpaper:2020-023

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