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Title: Expectations, Deflation Traps and Macroeconomic Policy

Author(s): George W. Evans and Seppo Honkapohja

Publication Date: August 2009

Keyword(s): Adaptive Learning, Fiscal Policy, Monetary Policy and Zero Interest Rate Lower Bound

Programme Area(s): International Macroeconomics

Abstract: We examine global economic dynamics under infinite-horizon learning in a New Keynesian model in which the interest-rate rule is subject to the zero lower bound. As in Evans, Guse and Honkapohja (2008), we find that under normal monetary and fiscal policy the intended steady state is locally but not globally stable. Unstable deflationary paths can arise after large pessimistic shocks to expectations. For large expectation shocks pushing interest rates to the zero lower bound, temporary increases in government spending can be used to insulate the economy from deflation traps.

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Bibliographic Reference

Evans, G and Honkapohja, S. 2009. 'Expectations, Deflation Traps and Macroeconomic Policy'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=7397