Expectations, Deflation Traps and Macroeconomic Policy

38 Pages Posted: 28 Nov 2009

See all articles by Seppo Honkapohja

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

George W. Evans

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

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Date Written: November 25, 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, 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.

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

JEL Classification: E63, E52, E58

Suggested Citation

Honkapohja, Seppo and Honkapohja, Seppo and Evans, George W., Expectations, Deflation Traps and Macroeconomic Policy (November 25, 2009). Bank of Finland Research Discussion Paper No. 24/2009, Available at SSRN: https://ssrn.com/abstract=1513232 or http://dx.doi.org/10.2139/ssrn.1513232

Seppo Honkapohja (Contact Author)

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

George W. Evans

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

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