Working Paper: NBER ID: w19248
Authors: S. Boraan Aruoba; Pablo Cubaborda; Frank Schorfheide
Abstract: We propose and solve a small-scale New-Keynesian model with Markov sunspot shocks that move the economy between a targeted-inflation regime and a deflation regime and fit it to data from the U.S. and Japan. For the U.S. we find that adverse demand shocks have moved the economy to the zero lower bound (ZLB) in 2009 and an expansive monetary policy has kept it there subsequently. In contrast, Japan has experienced a switch to the deflation regime in 1999 and remained there since then, except for a short period. The two scenarios have drastically different implications for macroeconomic policies. Fiscal multipliers are about 20% smaller in the deflationary regime, despite the economy remaining at the ZLB. While a commitment by the central bank to keep rates near the ZLB doubles the fiscal multipliers in the targeted-inflation regime (U.S.), it has no effect in the deflation regime (Japan).
Keywords: New Keynesian model; zero lower bound; deflation regime; fiscal multipliers
JEL Codes: C5; E4
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| adverse demand shocks (E00) | US economy reaches ZLB (E49) |
| expansionary monetary policy (E52) | US economy maintains ZLB (E49) |
| Japan transitions to deflation regime (E31) | 1999 (Y40) |
| deflation regime (E31) | fiscal multipliers smaller (E62) |
| commitment to keep rates near ZLB (E52) | fiscal multipliers double (E62) |
| commitment to keep rates near ZLB (E52) | no effect in deflation regime (E31) |