Self-fulfilling deflations |
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| Institution: | 1. Newcastle University Business School, 5 Barrack Road, Newcastle upon Tyne NE1 4SE, UK;2. CeNDEF, Amsterdam School of Economics, Universiteit van Amsterdam, Roetersstraat 11, 1018 WB Amsterdam, The Netherlands;1. Key Laboratory of Green Chemistry & Technology of Ministry of Education, College of Chemistry, Sichuan University, Chengdu, Sichuan 610064, China;2. Analytical & Testing Center, Sichuan University, Chengdu, Sichuan 610064, China;1. CentraleSupélec, France;2. Paris School of Economics, Université Paris I Panthéon-Sorbonne, France;1. Amity University Maharashtra, Bhatan, Post – Somathne, Navi Mumbai 410221, India;2. Amity University Rajasthan, SP-1, Kant Kalwar, RIICO Industrial Area, NH-11C, Jaipur 302006, India;3. Manipal University Jaipur, Dehmi Kalan, Near GVK Toll Plaza, Jaipur-Ajmer Expressway, Jaipur 303007, India |
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| Abstract: | What types of monetary and fiscal policy rules produce self-fulfilling deflationary paths that are monotonic and empirically relevant? This paper presents simple theoretical conditions that guarantee the existence of these paths in a general equilibrium model with sticky prices. These sufficient conditions are weak enough to be satisfied by most monetary and fiscal policy rules. A quantification of the model which combines a real shock à la Hayashi and Prescott (2002) with a simultaneous sunspot that deanchors inflation expectations matches the main empirical features of the Japanese deflationary process during the “lost decade”. The results also highlight the key role of the assumption about the anchoring of inflation expectations for the size of fiscal multipliers and, in general, for any policy analysis. |
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| Keywords: | Deflation Liquidity trap Deanchoring Inflation target Sunspot |
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