Working Paper: NBER ID: w23725
Authors: Jasmina Arifovic; Stephanie Schmittgroh; Martn Uribe
Abstract: The Taylor rule in combination with the zero lower bound on nominal rates has been shown to create an unintended liquidity-trap equilibrium. The relevance of this equilibrium has been challenged on the basis that it is not stable under least-square learning. In this paper, we show that the liquidity-trap equilibrium is stable under social learning. The learning mechanism we employ includes three realistic elements: mutation, crossover, and tournaments. We show that agents can learn to have pessimistic sentiments about the central bank's ability to generate price growth, giving rise to a stochastically stable environment characterized by deflation and stagnation.
Keywords: Liquidity Trap; Social Learning; Taylor Rule
JEL Codes: E03; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| social learning mechanisms (mutation, crossover, and tournaments) (C73) | agents' expectations (D84) |
| agents' expectations (D84) | economic outcomes (F61) |
| social learning mechanisms (mutation, crossover, and tournaments) (C73) | stability of liquidity trap equilibrium (C62) |
| agents' perceived laws of motion (C69) | stability of liquidity trap equilibrium (C62) |
| historical data from the liquidity trap (E41) | prevailing expectations (D84) |
| tournaments (L83) | belief formation process (D83) |
| belief formation process (D83) | agents' expectations (D84) |
| agents' expectations (D84) | economic activity (E20) |
| large perturbation in agents' perceived laws of motion (C69) | stable dynamic path around the liquidity trap (E12) |