Working Paper: CEPR ID: DP15171
Authors: Seppo Honkapohja; George W. Evans; Kaushik Mitra
Abstract: Stagnation and fiscal policy are examined in a nonlinear stochastic New-Keynesian model with adaptive learning. There are three steady states. The steady state targeted by policy is locally but not globally stable under learning. A severe pessimistic expectations shock can trap the economy in a stagnation regime, underpinned by a low-level steady state, with falling inflation and output. A large fiscal stimulus may be needed to avoid or emerge from stagnation, and the impacts of forward guidance, credit frictions, central bank credibility and policy delay are studied. Our model encompasses a wide range of outcomes arising from pessimistic expectations shocks.
Keywords: stagnation; trap; expectations; fiscal policy; adaptive learning; New Keynesian model
JEL Codes: E62; E63; E52; D84; E71
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| pessimistic expectations shocks (D84) | stagnation regime (P24) |
| stagnation regime (P24) | low output (E23) |
| stagnation regime (P24) | falling inflation (E31) |
| fiscal stimulus (E62) | escape from stagnation (P27) |
| large fiscal stimulus (E62) | return to targeted steady state (C62) |
| small fiscal stimulus (E62) | no change in stagnation (D50) |
| private sector expectations under adaptive learning (D84) | differences in economic outcomes (P17) |
| initial conditions (C62) | trajectory of the economy (E32) |
| credibility of fiscal and monetary policy (E63) | trajectory of the economy (E32) |