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

Seppo Honkapohja, Jess Benhabib and George Evans

No 9176, CEPR Discussion Papers from Centre for Economic Policy Research

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.

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: 2012-10
New Economics Papers: this item is included in nep-mac
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Citations: View citations in EconPapers (3)

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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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