Research Discussion Papers, Bank of Finland
George W Evans and Seppo Honkapohja
Expectations, deflation traps and macroeconomic policy
Abstract: We examine global economic dynamics under infinite-horizon
learning in a New Keynesian model in which the interest-rate rule is
subject to the zero lower bound. As in Evans, Guse and Honkapohja, European
Economic Review (2008), we find that under normal monetary and fiscal
policy the intended steady state is locally but not globally stable.
Unstable deflationary paths can arise after large pessimistic shocks to
expectations. For large expectation shocks that push interest rates to the
zero lower bound, temporary increases in government spending can
effectively insulate the economy from deflation traps.
Keywords: adaptive learning; monetary policy; fiscal policy; zero interest rate lower bound; (follow links to similar papers)
JEL-Codes: E52; E58; E63; (follow links to similar papers)
35 pages, September 22, 2009
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