DP15422 Expectations-driven liquidity traps: Implications for monetary and fiscal policy
|Author(s):||Taisuke Nakata, Sebastian Schmidt|
|Publication Date:||November 2020|
|Keyword(s):||discretion, effective lower bound, Fiscal policy, monetary policy, Policy Delegation, Sunspot equilibria|
|JEL(s):||E52, E61, E62|
|Programme Areas:||Monetary Economics and Fluctuations|
|Link to this Page:||cepr.org/active/publications/discussion_papers/dp.php?dpno=15422|
We study optimal time-consistent monetary and fiscal policy in a New Keynesian model where occasional declines in agents' confidence give rise to persistent liquidity trap episodes. Insights from widely-studied fundamental-driven liquidity traps are not a useful guide for enhancing welfare in this model. Raising the inflation target, appointing an inflation-conservative central banker, or allowing for the use of government spending as an additional stabilization tool can exacerbate deflationary pressures and demand deficiencies during the liquidity trap episodes. However, appointing a policymaker who is sufficiently less concerned with government spending stabilization than society eliminates expectations-driven liquidity traps.