Liquidity Traps, Learning and Stagnation

38 Pages Posted: 23 May 2008

See all articles by George W. Evans

George W. Evans

University of Oregon - Department of Economics; University of St. Andrews - School of Economics and Finance

Eran Guse

University of Cambridge - Faculty of Economics and Politics

Seppo Honkapohja

Centre for Economic Policy Research (CEPR); Aalto University School of Business; CESifo (Center for Economic Studies and Ifo Institute for Economic Research); Aalto University - School of Business

Date Written: June 2007

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 Classification: E52, E58, E63

Suggested Citation

Evans, George W. and Guse, Eran A. and Honkapohja, Seppo and Honkapohja, Seppo, Liquidity Traps, Learning and Stagnation (June 2007). CEPR Discussion Paper No. DP6355, Available at SSRN: https://ssrn.com/abstract=1136681

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)

University of St. Andrews - School of Economics and Finance ( email )

The Scores, Castlecliff
St. Andrews, Fife KY16 8RD
United Kingdom
44-1334-462435 (Phone)

HOME PAGE: http://www.st-andrews.ac.uk/economics/staff/pages.g.evans.shtml

Eran A. Guse

University of Cambridge - Faculty of Economics and Politics ( email )

Austin Robinson Building
Sidgwick Avenue
Cambridge, CB3 9DD
United Kingdom

Seppo Honkapohja

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Aalto University School of Business ( email )

, PO Box 21210
Aalto FI-00076
Finland

CESifo (Center for Economic Studies and Ifo Institute for Economic Research)

Poschinger Str. 5
Munich, DE-81679
Germany

HOME PAGE: http://www.CESifo.de

Aalto University - School of Business

Finland

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