Liquidity traps and expectation dynamics : fiscal stimulus or fiscal austerity?
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.
Citation
Benhabib , J , Evans , G W & Honkapohja , S 2014 , ' Liquidity traps and expectation dynamics : fiscal stimulus or fiscal austerity? ' , Journal of Economic Dynamics and Control , vol. 45 , pp. 220-238 . https://doi.org/10.1016/j.jedc.2014.05.021
Publication
Journal of Economic Dynamics and Control
Status
Peer reviewed
ISSN
0165-1889Type
Journal article
Description
Financial support from National Science Foundation Grant no. SES-1025011 is gratefully acknowledged.Collections
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