Role of Expectation in a Liquidity Trap

Kohei Hasui, Yoshiyuki Nakazono and Yuki Teranishi

No 81, UTokyo Price Project Working Paper Series from University of Tokyo, Graduate School of Economics

Abstract: This paper investigates how expectation formation affects monetary policy ef- fectiveness in a liquidity trap. We examine two expectation formations: (i) different degrees in anchoring expectation and (ii) different degrees in forward-lookingness to form expectation. We reveal several points as follows. First, under optimal commitment policy, expectation formation for an inflation rate does not markedly change the effects of monetary policy. Second, contrary to optimal commitment policy, the effects of monetary policy significantly change according to different inflation expectation formations under the Taylor rule. The reductions to an infla- tion rate and the output gap are mitigated if the expectation is well anchored. This rule, however, can not avoid large drops when the degree of forward-lookingness to form expectation decreases. Third, a simple rule with price-level targeting shows some similar outcomes according to different expectation formations as the Taylor rule does. However, in a simple rule with price-level targeting, an inflation rate and the output gap drop less severe due to a history dependent easing and are less sensitive to expectation formations than in the Taylor rule. Even for the Japanese economy, the effects of monetary policy on economic dynamics significantly change according to expectation formations for rules except optimal commitment policy. Furthermore, when the same expectation formations for the output gap are as- sumed, we observe similar outcomes.

Keywords: Expectation; Liquidity Trap; Monetary Policy (search for similar items in EconPapers)
JEL-codes: E31 E52 E58 E61 (search for similar items in EconPapers)
Pages: 52 pages
Date: 2018-02
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
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Related works:
Journal Article: Role of expectations in a liquidity trap (2019)
Working Paper: Role of expectations in a liquidity trap (2019)
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Persistent link: https://EconPapers.repec.org/RePEc:upd:utppwp:081

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