Kiel Working Papers, Kiel Institute for World Economics
No 1341:
Liquidity Traps, Learning and Stagnation
George Evans, Eran Guse and Seppo Honkapohja
Abstract: We examine global economic dynamics under learning in a
New Keynesian model in which the interest-rate rule is subject to the zero
lower bound. Under normal monetary and fiscal policy, the intended steady
state is locally but not globally stable. Large pessimistic shocks to
expectations can lead to deflationary spirals with falling prices and
falling output. To avoid this outcome we recommend augmenting normal
policies with aggressive monetary and fiscal policy that guarantee a lower
bound on inflation. In contrast, policies geared toward ensuring an output
lower bound are insufficient for avoiding deflationary spirals.
Keywords: Adaptive Learning, Monetary Policy, Fiscal Policy, Zero Interest Rate Lower Bound, Indeterminacy; (follow links to similar papers)
JEL-Codes: E63,; E52,; E58; (follow links to similar papers)
34 pages, June 2007
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