Working Paper: NBER ID: w30117
Authors: Luba Petersen; Ryan Rholes
Abstract: We design a new experimental framework to study policy interventions to combat secular stagnations and liquidity traps in an overlapping-generations environment where participants form expectations and make real economic decisions. We observe that participants can learn to coordinate on high inflation full-employment equilibria. Permanent deleveraging shocks induce pessimistic, backward-looking expectations and considerable consumption heterogeneity as the economies experience persistent deflation. We explore the ability of unconventional monetary policy to lead economies out of deflationary traps. Permanently increasing the central bank's inflation target is insufficient to generate inflationary expectations due to low central bank credibility. Negative interest rates stimulate spending and generate the necessary inflation for the economies to escape the zero lower bound. Negative interest rates are more potent than raising the inflation target at shifting consumption to the present.
Keywords: unconventional monetary policy; secular stagnation; negative interest rates; inflation expectations
JEL Codes: C92; E03; E52; E70
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| negative interest rates (E43) | spending (H72) |
| spending (H72) | inflation expectations (E31) |
| inflation expectations (E31) | full-employment equilibrium (D59) |
| negative interest rates (E43) | inflation necessary for escaping deflationary traps (E31) |
| increasing inflation target (E31) | consumer behavior (D19) |
| deleveraging shocks (F65) | pessimistic backward-looking expectations (D84) |
| pessimistic backward-looking expectations (D84) | consumption heterogeneity (D11) |
| pessimistic backward-looking expectations (D84) | persistent deflation (E31) |
| negative interest rates (E43) | economic recovery (E65) |
| inflation target increases (E31) | inflation expectations (E31) |
| inflation target increases (E31) | consumption (E21) |