Liquidity traps and expectation dynamics: fiscal stimulus or fiscal austerity?

Jess Benhabib; George W Evans; Seppo Honkapohja

doi:10.1016/j.jedc.2014.05.021

Liquidity traps and expectation dynamics: fiscal stimulus or fiscal austerity?

Jess Benhabib, George W Evans, Seppo Honkapohja

Research output: Contribution to journal › Article › peer-review

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. 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 in some cases a policy of fiscal austerity, will insulate the economy from deflation traps if the policy is appropriately tailored in magnitude and duration. A fiscal stimulus "switching rule," which automatically kicks in without discretionary fine-tuning, can be equally effective.

Original language	English
Pages (from-to)	220-238
Number of pages	19
Journal	Journal of Economic Dynamics and Control
Volume	45
Early online date	7 Jun 2014
DOIs	https://doi.org/10.1016/j.jedc.2014.05.021
Publication status	Published - Aug 2014

Keywords

Adaptive learning
Monetary policy
Fiscal policy
Zero interest rate lower bound

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10.1016/j.jedc.2014.05.021

stimulusausteritypaper28april2014
© 2014. Elsevier Inc. All rights reserved. This is the author’s version of a work that was accepted for publication in Journal of Economic Dynamics & Control. Changes resulting from the publishing process, such as peer review, editing, corrections, structural formatting, and other quality control mechanisms may not be reflected in this document. Changes may have been made to this work since it was submitted for publication. A definitive version was subsequently published in Journal of Economic Dynamics and Control, 45, August 2014 DOI http://dx.doi.org/10.1016/j.jedc.2014.05.021
Accepted author manuscript, 368 KB

George W Evans
- ge21st-andrews.acuk
- Economics (Business School) - Professor
Person: Academic

1 Article

Liquidity Traps and Expectation Dynamics: Fiscal Stimulus or Fiscal Austerity?
Benhabib, J., Evans, G. W. & Honkapohja, S., 2012, In: National Bureau of Economic Research Working Paper Series. No. 18114
Research output: Contribution to journal › Article › peer-review

Cite this

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title = "Liquidity traps and expectation dynamics: fiscal stimulus or fiscal austerity?",

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. 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 in some cases a policy of fiscal austerity, will insulate the economy from deflation traps if the policy is appropriately tailored in magnitude and duration. A fiscal stimulus {"}switching rule,{"} which automatically kicks in without discretionary fine-tuning, can be equally effective. ",

keywords = "Adaptive learning, Monetary policy, Fiscal policy, Zero interest rate lower bound",

author = "Jess Benhabib and Evans, {George W} and Seppo Honkapohja",

note = "Financial support from National Science Foundation Grant no. SES-1025011 is gratefully acknowledged.",

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AU - Benhabib, Jess

AU - Evans, George W

AU - Honkapohja, Seppo

N1 - Financial support from National Science Foundation Grant no. SES-1025011 is gratefully acknowledged.

PY - 2014/8

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AB - We examine global dynamics under infinite-horizon learning in New Keynesian models where the interest-rate rule is subject to the zero lower bound. 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 in some cases a policy of fiscal austerity, will insulate the economy from deflation traps if the policy is appropriately tailored in magnitude and duration. A fiscal stimulus "switching rule," which automatically kicks in without discretionary fine-tuning, can be equally effective.

KW - Adaptive learning

KW - Monetary policy

KW - Fiscal policy

KW - Zero interest rate lower bound

U2 - 10.1016/j.jedc.2014.05.021

DO - 10.1016/j.jedc.2014.05.021

M3 - Article

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SP - 220

EP - 238

JO - Journal of Economic Dynamics and Control

JF - Journal of Economic Dynamics and Control

ER -

Liquidity traps and expectation dynamics: fiscal stimulus or fiscal austerity?

Abstract

Keywords

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George W Evans

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Liquidity Traps and Expectation Dynamics: Fiscal Stimulus or Fiscal Austerity?

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