Policy Effects in a Simple Fully Non-Linear New Keynesian Model of the Liquidity Trap

34 Pages Posted: 1 Feb 2017

Date Written: February 1, 2017

Abstract

We analyze a simple yet fully non-linear New Keynesian model of the liquidity trap. Productivity shocks are the only source of aggregate fluctuations and the central bank acts as a discretionary policy maker that pursues an inflation targeting strategy. We use this model to assess the effects of fiscal policy in a liquidity trap, the consequences of a commitment to change government expenditures in the future as well as the implications of lower taxes on labor and a higher inflation target. In contrast with some previous papers, we find that the effects of fiscal policy in a liquidity trap are moderate and that reductions in labor income taxes are expansionary. We do not find support for higher inflation targets.

Keywords: zero lower bound, fiscal multiplier, liquidity trap, new Keynesian model, multiple equilibria, inflation target

JEL Classification: E52, E58, E62

Suggested Citation

Hahn, Volker, Policy Effects in a Simple Fully Non-Linear New Keynesian Model of the Liquidity Trap (February 1, 2017). Available at SSRN: https://ssrn.com/abstract=2909525 or http://dx.doi.org/10.2139/ssrn.2909525

Volker Hahn (Contact Author)

University of Konstanz ( email )

Box 143
Konstanz, 78457
Germany

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