Discussion paper

DP15422 Expectations-driven liquidity traps: Implications for monetary and fiscal policy

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.

£6.00
Citation

Nakata, T and S Schmidt (2020), ‘DP15422 Expectations-driven liquidity traps: Implications for monetary and fiscal policy‘, CEPR Discussion Paper No. 15422. CEPR Press, Paris & London. https://cepr.org/publications/dp15422