Expectations, Stagnation and Fiscal Policy

97 Pages Posted: 15 Aug 2016

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

Kaushik Mitra

University of Birmingham

Multiple version iconThere are 2 versions of this paper

Date Written: 2016

Abstract

Stagnation as the new norm and fiscal policy are examined in a New Keynesian model with adaptive learning determining expectations. We impose inflation and consumption lower bounds, which can be relevant when agents are pessimistic. The inflation target is locally stable under learning. Pessimistic initial expectations may sink the economy into steady-state stagnation with deflation. The deflation rate can be near zero for discount factors near one or if credit frictions are present. Following a severe pessimistic expectations shock a large temporary fiscal stimulus is needed to avoid or emerge from stagnation. A modest stimulus is sufficient if implemented early.

Keywords: E62, D84, E21, E43, stagnation, deflation, expectations, output multiplier, New Keynesian model, adaptive learning, fiscal policy

Suggested Citation

Evans, George W. and Honkapohja, Seppo and Honkapohja, Seppo and Mitra, Kaushik, Expectations, Stagnation and Fiscal Policy (2016). Bank of Finland Research Discussion Paper No. 25/2016, Available at SSRN: https://ssrn.com/abstract=2823455 or http://dx.doi.org/10.2139/ssrn.2823455

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

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

Kaushik Mitra

University of Birmingham ( email )

Edgbaston, Birmingham B15 2TT
United Kingdom

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