Expectations, Stagnation and Fiscal Policy

Seppo Honkapohja, Kaushik Mitra and George Evans

No 160, 2017 Meeting Papers from Society for Economic Dynamics

Abstract: Persistent stagnation and fiscal policy are examined in a New Keynesian model with adaptive learning determining expectations. We impose inflation and consumption lower bounds, which can be relevant when agents are pessimistic. The inflation target is locally but not globally stable under learning. Pessimistic initial expectations may sink the economy into steady-state stagnation with deflation. The deflation rate can be near zero for discount factors near one or if credit frictions are present. Following a severe pessimistic expectations shock a large temporary fiscal stimulus is needed to avoid or emerge from stagnation. A modest stimulus is sufficient if implemented early.

Date: 2017
New Economics Papers: this item is included in nep-dge and nep-mac
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Related works:
Working Paper: Expectations, Stagnation and Fiscal Policy (2016)
Working Paper: Expectations, stagnation and fiscal policy (2016)
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed017:160

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