Liquidity traps and expectation dynamics: Fiscal stimulus or fiscal austerity?

Jess Benhabib, George Evans and Seppo Honkapohja

Journal of Economic Dynamics and Control, 2014, vol. 45, issue C, 220-238

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. 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 in some cases a policy of fiscal austerity, will insulate the economy from deflation traps if the policy is appropriately tailored in magnitude and duration. A fiscal stimulus “switching rule,” which automatically kicks in without discretionary fine-tuning, can be equally effective.

Keywords: Adaptive learning; Monetary policy; Fiscal policy; Zero interest rate lower bound (search for similar items in EconPapers)
JEL-codes: E52 E58 E63 (search for similar items in EconPapers)
Date: 2014
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Citations: View citations in EconPapers (54)

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Related works:
Working Paper: Liquidity Traps and Expectation Dynamics: Fiscal Stimulus or Fiscal Austerity? (2012)
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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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:45:y:2014:i:c:p:220-238

DOI: 10.1016/j.jedc.2014.05.021

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