Economics, Econometrics and Finance
4 years ago

Expectation overreactions at zero lower bound worsen economic crises, fiscal stimulus key

Journal of Economic Dynamics and Control
Stabilizing expectations at the zero lower bound: Experimental evidence
Jasmina Arifovic, Luba Petersen

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Agents' expectations can impact monetary and fiscal policies at the zero lower bound. In an experiment, subjects' expectations led to severe deflationary traps due to over-reactions to shocks. Communicating state-dependent inflation targets did not help. Introducing anticipated fiscal stimulus reduced recession severity. Slow fundamental recovery made policies ineffective in stabilizing the economy.