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

Jess Benhabib (), George Evans () and Seppo Honkapohja ()

No 201407, CDMA Working Paper Series from Centre for Dynamic Macroeconomic Analysis

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: E63 E52 E58 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-mac
Date: 2014-04-28
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Related works:
Journal Article: Liquidity traps and expectation dynamics: Fiscal stimulus or fiscal austerity? (2014) Downloads
Working Paper: Liquidity trap and expectation dynamics: Fiscal stimulus or fiscal austerity? (2012) Downloads
Working Paper: Liquidity Traps and Expectation Dynamics: Fiscal Stimulus or Fiscal Austerity? (2012) Downloads
Working Paper: Liquidity Traps and Expectation Dynamics: Fiscal Stimulus or Fiscal Austerity? (2012) Downloads
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