Fiscal stimulus in expectations-driven liquidity traps
I study liquidity traps in a model where agents have heterogeneous expectations and finite planning horizons. Backward-looking agents base their expectations on past observations, while forward-looking agents have fully rational expectations. Liquidity traps that are fully or partly driven by expect...
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| Main Author: | |
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| Format: | Book/Monograph Working Paper |
| Language: | English |
| Published: |
Heidelberg
University of Heidelberg, Department of Economics
14 May 2020
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| Series: | Discussion paper series / University of Heidelberg, Department of Economics
no. 683 |
| In: |
Discussion paper series (no. 683)
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| DOI: | 10.11588/heidok.00028307 |
| Subjects: | |
| Online Access: | Verlag, kostenfrei: http://archiv.ub.uni-heidelberg.de/volltextserver/28307/1/Lustenhouwer_2020_dp683.pdf Resolving-System, kostenfrei: https://doi.org/10.11588/heidok.00028307 Resolving-System, kostenfrei: http://hdl.handle.net/10419/235006 Resolving-System, kostenfrei, Volltext: https://nbn-resolving.org/urn:nbn:de:bsz:16-heidok-283071 
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| Author Notes: | Joep Lustenhouwer |
| Summary: | I study liquidity traps in a model where agents have heterogeneous expectations and finite planning horizons. Backward-looking agents base their expectations on past observations, while forward-looking agents have fully rational expectations. Liquidity traps that are fully or partly driven by expectations can arise due to pessimism of backward-looking agents. Only when planning horizons are finite, these liquidity traps can be of longer duration without ending up in a deflationary spiral. I further find that fiscal stimulus in the form of an increase in government spending or a cut in consumption taxes can be very effective in mitigating the liquidity trap. A feedback mechanism of heterogeneous expectations causes fiscal multipliers to be the largest when the majority of agents is backward-looking but there also is a considerable fraction of agents that are forward-looking. Labor tax cuts are always deflationary and are not an effective tool in a liquidity trap. |
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| Physical Description: | Online Resource |
| DOI: | 10.11588/heidok.00028307 |