TY - JOUR
T1 - Liquidity traps and expectation dynamics
T2 - Fiscal stimulus or fiscal austerity?
AU - Benhabib, Jess
AU - Evans, George W.
AU - Honkapohja, Seppo
N1 - Funding Information:
Financial support from National Science Foundation Grant no. SES-1025011 is gratefully acknowledged. We are grateful for the comments by the referee, Sebastian Schmidt, Benoit Mojon, Albert Marcet and comments received in conferences at Saint Louis Federal Reserve Bank, Bank of Spain, Swiss National Bank, and in various seminars. Any views expressed are those of the authors and do not necessarily reflect the views of the Bank of Finland.
PY - 2014/8
Y1 - 2014/8
N2 - 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.
AB - 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.
KW - Adaptive learning
KW - Fiscal policy
KW - Monetary policy
KW - Zero interest rate lower bound
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U2 - 10.1016/j.jedc.2014.05.021
DO - 10.1016/j.jedc.2014.05.021
M3 - Article
AN - SCOPUS:84904874515
VL - 45
SP - 220
EP - 238
JO - Journal of Economic Dynamics and Control
JF - Journal of Economic Dynamics and Control
SN - 0165-1889
ER -