Working Paper: NBER ID: w18114
Authors: Jess Benhabib; George W. Evans; Seppo Honkapohja
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. As in Evans, Guse and Honkapohja (2008), 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 a policy of fiscal austerity, appropriately tailored in magnitude and duration, will insulate the economy from deflation traps. However "fiscal switching rules" that automatically kick in without discretionary fine tuning can be equally effective.
Keywords: liquidity traps; fiscal stimulus; fiscal austerity; expectation dynamics
JEL Codes: E52; E58; E63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| temporary fiscal stimulus (E62) | economy back to its intended steady state (E13) |
| temporary fiscal stimulus (E62) | counteract adverse effects of pessimistic expectations (D91) |
| fiscal austerity (E62) | effective under certain conditions (C20) |
| fiscal policies (H30) | economic stability (E63) |
| fiscal switching rule (E62) | stabilize the economy (E63) |