Escaping Expectations-Driven Liquidity Traps: Experimental Evidence

Luba Petersen and Jasmina Arifovic

Discussion Papers from Department of Economics, Simon Fraser University

Abstract: Can monetary or fiscal policy stabilize expectations in a liquidity trap? We study expectation formation near the zero lower bound using a learning-to-forecast laboratory experiment. Monetary policy targets inflation around a constant or state-dependent target. Subjects’ expectations significantly over-react to stochastic aggregate demand shocks and historical information leading many economies to experience severe deflationary traps. Neither quantitative nor qualitative communication of inflation targets reduce the duration or severity of economic crises. A stronger initial recovery of fundamentals or supplementary anticipated fiscal stimulus stabilizes expectations and increases the speed of macroeconomic recovery.

Keywords: experimental macroeconomics; monetary policy; expectations; zero lower bound; learning to forecast; communication (search for similar items in EconPapers)
JEL-codes: C92 D50 D91 E2 E52 (search for similar items in EconPapers)
Pages: 82
Date: 2015-03-14
New Economics Papers: this item is included in nep-cba, nep-exp, nep-mac and nep-mon
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