The Stagnation Regime of the New Keynesian Model and Current US Policy

In Evans, Guse, and Honkapohja (2008) the intended steady state is locally but not globally stable under adaptive learning, and unstable deflationary paths can arise after large pessimistic shocks to expectations. In the current paper a modified model is presented that includes a locally stable stagnation regime as a possible outcome arising from large expectation shocks. Policy implications are examined. Sufficiently large temporary increases in government spending can dislodge the economy from the stagnation regime and restore the natural stabilizing dynamics. More specific policy proposals are presented and discussed.Stagnation, fiscal and monetary policy, deflation trap.

Monetary and Fiscal Policy under Learning in the Presence of a Liquidity Trap

This paper reports on the findings of Evans, Guse, and Honkapohja (2007) concerning the global economic dynamics under learning in a New Keynesian model in which the interest rate rule is subject to the zero lower bound. Under normal monetary and fiscal policy, the intended steady state is locally but not globally stable. Large pessimistic shocks to expectations can lead to deflationary spirals with falling prices and falling output. To avoid this outcome, we recommend augmenting normal policies with inflation threshold policies: if under normal policies inflation would fall below a suitably chosen threshold, these policies should be replaced by aggressive monetary and fiscal policies that guarantee this lower bound on inflation.Adaptive learning; Monetary policy; Fiscal policy; Zero interest rate lower bound; Indeterminacy

Monetary policy, indeterminacy and learning

The development of tractable forward looking models of monetary policy has lead to an explosion of research on the implications of adopting Taylor-type interest rate rules. Indeterminacies have been found to arise for some specifications of the interest rate rule, raising the possibility of inefficient fluctuations due to the dependence of expectations on extraneous "sunspots ". Separately, recent work by a number of authors has shown that sunspot equilibria previously thought to be unstable under private agent learning can in some cases be stable when the observed sunspot has a suitable time series structure. In this paper we generalize the "common factor "technique, used in this analysis, to examine standard monetary models that combine forward looking expectations and predetermined variables. We consider a variety of specifications that incorporate both lagged and expected inflation in the Phillips Curve, and both expected inflation and inertial elements in the policy rule. We find that some policy rules can indeed lead to learnable sunspot solutions and we investigate the conditions under which this phenomenon arises