Self-Fulfilling Deflations

48 Pages Posted: 11 Jan 2017

Date Written: September 29, 2016

Abstract

What types of monetary and fiscal policy rules produce self-fulfilling deflationary paths that are monotonic and empirically relevant? This paper presents simple theoretical conditions that guarantee the existence of these paths in a general equilibrium model with sticky prices. These sufficient conditions are weak enough to be satisfied by most monetary and fiscal policy rules. A quantification of the model which combines a real shock à la Hayashi and Prescott (2002) with a simultaneous sunspot that deanchors inflation expectations matches the main empirical features of the Japanese deflationary process during the “lost decade”. The results also highlight the key role of the assumption about the anchoring of inflation expectations for the size of fiscal multipliers and, in general, for any policy analysis.

Keywords: deflation, liquidity trap, deanchoring, inflation target, sunspot

JEL Classification: E31, E40, E43

Suggested Citation

Piazza, Roberto, Self-Fulfilling Deflations (September 29, 2016). Bank of Italy Temi di Discussione (Working Paper) No. 1080, Available at SSRN: https://ssrn.com/abstract=2896787 or http://dx.doi.org/10.2139/ssrn.2896787

Roberto Piazza (Contact Author)

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

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