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Policy Effects in a Simple Fully Non-Linear New Keynesian Model of the Liquidity Trap

Volker Hahn ()

No 2017-05, Working Paper Series of the Department of Economics, University of Konstanz from Department of Economics, University of Konstanz

Abstract: We analyze a simple yet fully non-linear New Keynesian model with a central bank that pursues an inflation targeting strategy. Our analysis shows that expected adverse productivity shocks may drive the economy into a liquidity trap. As our model entails positive or moderately negative inflation in such a situation, it has the potential to explain the so-called “missing disinflation” in the Great Recession. In contrast with some previous papers, we find that the effects of fiscal policy in a liquidity trap are moderate and that reductions in labor income taxes are expansionary. We do not find support for higher inflation targets. Finally, we provide additional support for the view that the common practice of log-linearizing equilibrium relations can be potentially misleading in models with a lower bound on nominal interest rates.

Keywords: Zero lower bound; missing disinflation; fiscal multiplier; liquidity trap; new Keynesian model; multiple equilibria; inflation target (search for similar items in EconPapers)
JEL-codes: E52 E58 E62 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-dcm, nep-mac and nep-mon
Date: 2017-05-18
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