Expectations formation, sticky prices, and the ZLB

Betsy Bersson, Patrick Hürtgen and Matthias Paustian

No 34/2019, Discussion Papers from Deutsche Bundesbank

Abstract: At the zero lower bound (ZLB), expectations about the future path of monetary or fiscal policy are crucial. We model expectations formation under level-k thinking, a form of bounded rationality introduced by García-Schmidt and Woodford (2019) and Farhi and Werning (2017), consistent with experimental evidence. This process does not lead to a number of puzzling features from rational expectations models, such as the forward guidance and the reversal puzzle, or implausible large fiscal multipliers. Optimal monetary policy at the ZLB under level-k thinking prescribes keeping the nominal rate lower for longer, but short-run macroeconomic stabilization is less powerful compared to rational expectations.

Keywords: expectations formation; optimal monetary policy; New Keynesian model; zero lower bound; forward guidance puzzle; reversal puzzle; fiscal multiplier (search for similar items in EconPapers)
JEL-codes: E32 (search for similar items in EconPapers)
Date: 2019
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

Downloads: (external link)
https://www.econstor.eu/bitstream/10419/204451/1/1677599553.pdf (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:zbw:bubdps:342019

Access Statistics for this paper

More papers in Discussion Papers from Deutsche Bundesbank Contact information at EDIRC.
Bibliographic data for series maintained by ZBW - Leibniz Information Centre for Economics ().