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Liquidity Traps, Learning and Stagnation

George Evans (), Eran Guse and Seppo Honkapohja ()

No 6355, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We examine global economic dynamics under learning in a New Keynesian model in which the interest-rate rule is subject to the zero lower bound. Under normal monetary and fiscal policy, the intended steady state is locally but not globally stable. Large pessimistic shocks to expectations can lead to deflationary spirals with falling prices and falling output. To avoid this outcome we recommend augmenting normal policies with aggressive monetary and fiscal policy that guarantee a lower bound on inflation. In contrast, policies geared toward ensuring an output lower bound are insufficient for avoiding deflationary spirals.

Keywords: adaptive learning; fiscal policy; indeterminacy; monetary policy; zero interest rate lower bound (search for similar items in EconPapers)
JEL-codes: E52 E58 E63 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
Date: 2007-06
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Journal Article: Liquidity traps, learning and stagnation (2008) Downloads
Working Paper: Liquidity Traps, Learning and Stagnation (2007) Downloads
Working Paper: Liquidity Traps, Learning and Stagnation (2007) Downloads
Working Paper: Liquidity Traps, Learning and Stagnation (2007) Downloads
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