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Expectations, stagnation and fiscal policy

George Evans (), Seppo Honkapohja () and Kaushik Mitra

No 25/2016, Research Discussion Papers from Bank of Finland

Abstract: Stagnation as the new norm 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 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.

JEL-codes: E62 D84 E21 E43 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-dge and nep-mac
Date: 2016-08-11
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Related works:
Working Paper: Expectations, Stagnation and Fiscal Policy (2017) Downloads
Working Paper: Expectations, Stagnation and Fiscal Policy (2016) Downloads
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