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Liquidity Traps, Learning and Stagnation

George W. Evans
University of Oregon - Department of Economics

Eran Guse
University of Cambridge - Faculty of Economics and Politics

Seppo Honkapohja
Bank of Finland; University of Cambridge - Faculty of Economics and Politics; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR); CESifo (Center for Economic Studies and Ifo Institute for Economic Research)


June 2007

CEPR Discussion Paper No. DP6355

Abstract:     
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.

Keywords: Adaptive learning, fiscal policy, indeterminacy, monetary policy, zero interest rate lower bound

JEL Classifications: E52, E58, E63

Working Paper Series

Date posted: May 23, 2008 ; Last revised: May 23, 2008

Suggested Citation

Evans, George W., Guse, Eran A. and Honkapohja, Seppo, Liquidity Traps, Learning and Stagnation (June 2007). , Vol. , pp. -, 2007. Available at SSRN: http://ssrn.com/abstract=1136681


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Contact Information

George W. Evans (Contact Author)
University of Oregon - Department of Economics ( email )
1285 University of Oregon
Eugene, OR 97403
United States
541-346-4662 (Phone)
541-346-1243 (Fax)
Eran A. Guse
University of Cambridge - Faculty of Economics and Politics ( email )
Austin Robinson Building
Sidgwick Avenue
Cambridge CB3 9DD United Kingdom
Seppo Honkapohja
Bank of Finland ( email )
P.O. Box 160
FIN-00101 Helsinki Finland
University of Cambridge - Faculty of Economics and Politics ( email )
Austin Robinson Building
Sidgwick Avenue
Cambridge CB3 9DD United Kingdom
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Centre for Economic Policy Research (CEPR)
90-98 Goswell Road
London EC1V 7RR United Kingdom
CESifo (Center for Economic Studies and Ifo Institute for Economic Research)
Poschinger Str. 5
DE-81679 Munich Germany
HOME PAGE: http://www.CESifo.de
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References: 28
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