Expectations, deflation traps and macroeconomic policy

George Evans and Seppo Honkapohja

No 24/2009, Bank of Finland Research Discussion Papers from Bank of Finland

Abstract: We examine global economic dynamics under infinite-horizon learning in a New Keynesian model in which the interest-rate rule is subject to the zero lower bound. As in Evans, Guse and Honkapohja, European Economic Review (2008), we find that under normal monetary and fiscal policy the intended steady state is locally but not globally stable. Unstable deflationary paths can arise after large pessimistic shocks to expectations. For large expectation shocks that push interest rates to the zero lower bound, temporary increases in government spending can effectively insulate the economy from deflation traps

Date: 2009
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Related works:
Working Paper: Expectations, Deflation Traps and Macroeconomic Policy (2010)
Working Paper: Expectations, Deflation Traps and Macroeconomic Policy (2009)
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