Liquidity Traps and Expectation Dynamics: Fiscal Stimulus or Fiscal Austerity?

Jess Benhabib, George Evans and Seppo Honkapohja

No 18114, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We examine global dynamics under infinite-horizon learning in New Keynesian models where the interest-rate rule is subject to the zero lower bound. As in Evans, Guse and Honkapohja (2008), the intended steady state is locally but not globally stable. Unstable deflationary paths emerge after large pessimistic shocks to expectations. For large expectation shocks that push interest rates to the zero bound, a temporary fiscal stimulus or a policy of fiscal austerity, appropriately tailored in magnitude and duration, will insulate the economy from deflation traps. However "fiscal switching rules" that automatically kick in without discretionary fine tuning can be equally effective.

JEL-codes: E52 E58 E63 (search for similar items in EconPapers)
Date: 2012-05
New Economics Papers: this item is included in nep-cba and nep-mac
Note: EFG
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Citations: View citations in EconPapers (3)

Published as “Liquidity Traps and Expectation Dynamics: Fiscal Stimulus or Fiscal Austerity?,” (with George Evans and Seppo Honkapohja), forthcoming, Journal of Economic Dynamics and Control, 2015.

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Related works:
Journal Article: Liquidity traps and expectation dynamics: Fiscal stimulus or fiscal austerity? (2014)
Working Paper: Liquidity Traps and Expectation Dynamics: Fiscal Stimulus or Fiscal Austerity? (2012)
Working Paper: Liquidity trap and expectation dynamics: Fiscal stimulus or fiscal austerity? (2012)
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