Expectations, Deflation Traps and Macroeconomic Policy

Evans, George W.; Honkapohja, Seppo

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Expectations, Deflation Traps and Macroeconomic Policy

CEPR Discussion Paper No. DP7397

35 Pages Posted: 8 Sep 2009

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

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

There are 2 versions of this paper

Date Written: August 2009

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 (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 pushing interest rates to the zero lower bound, temporary increases in government spending can be used to insulate the economy from deflation traps.

Keywords: Adaptive Learning, Fiscal Policy, Monetary Policy, Zero Interest Rate Lower Bound

JEL Classification: E52, E58, E63

Suggested Citation: Suggested Citation

Evans, George W. and Honkapohja, Seppo and Honkapohja, Seppo, Expectations, Deflation Traps and Macroeconomic Policy (August 2009). CEPR Discussion Paper No. DP7397, Available at SSRN: https://ssrn.com/abstract=1469876