Abstract
We examine global dynamics under infinite-horizon learning in New Keynesian models where the interest-rate rule is subject to the zero lower bound. The intended steady state is locally but not globally stable. Unstable deflationary paths emerge after large pessimistic shocks to expectations. For large expectation shocks that push interest rates to the zero bound, a temporary fiscal stimulus, or in some cases a policy of fiscal austerity, will insulate the economy from deflation traps if the policy is appropriately tailored in magnitude and duration. A fiscal stimulus "switching rule," which automatically kicks in without discretionary fine-tuning, can be equally effective.
Original language | English (US) |
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Pages (from-to) | 220-238 |
Number of pages | 19 |
Journal | Journal of Economic Dynamics and Control |
Volume | 45 |
DOIs | |
State | Published - Aug 2014 |
Keywords
- Adaptive learning
- Fiscal policy
- Monetary policy
- Zero interest rate lower bound
ASJC Scopus subject areas
- Economics and Econometrics
- Control and Optimization
- Applied Mathematics