Liquidity Traps, Learning and Stagnation
George W. Evans
University of Oregon - Department of Economics; University of Saint Andrews - School of Economics and Finance
University of Cambridge - Faculty of Economics and Politics
Bank of Finland; Centre for Economic Policy Research (CEPR); CESifo (Center for Economic Studies and Ifo Institute for Economic Research)
CEPR Discussion Paper No. DP6355
We examine global economic dynamics under learning in a New Keynesian model in which the interest-rate rule is subject to the zero lower bound. Under normal monetary and fiscal policy, the intended steady state is locally but not globally stable. Large pessimistic shocks to expectations can lead to deflationary spirals with falling prices and falling output. To avoid this outcome we recommend augmenting normal policies with aggressive monetary and fiscal policy that guarantee a lower bound on inflation. In contrast, policies geared toward ensuring an output lower bound are insufficient for avoiding deflationary spirals.
Number of Pages in PDF File: 38
Keywords: Adaptive learning, fiscal policy, indeterminacy, monetary policy, zero interest rate lower bound
JEL Classification: E52, E58, E63working papers series
Date posted: May 23, 2008
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