Macroeconomic Dynamics Near the ZLB: A Tale of Two Equilibria

S. Borağan Aruoba · Frank Schorfheide

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Monetary Policy and Economic Impact Economic Theory and Policy Economic theories and models

Abstract

This paper studies the dynamics of a New Keynesian dynamic stochastic general equilibrium (DSGE) model near the zero lower bound (ZLB) on nominal interest rates.In addition to the standard targeted-inflation equilibrium, we consider a deflation equilibrium as well as a Markov sunspot equilibrium that switches between a targetedinflation and a deflation regime.We use the particle filter to estimate the state of the U.S. economy during and after the 2008-09 recession under the assumptions that the U.S. economy has been in either the targeted-inflation or the sunspot equilibrium.We consider a combination of fiscal policy (calibrated to the American Recovery and Reinvestment Act) and monetary policy (that tries to keep interest rates near zero) and compute government spending multipliers.Ex-ante multipliers (cumulative over one year) under the targeted-inflation regime are around 0.9.A monetary policy that keeps interest rates at zero can raise the multiplier to 1.7.The ex-post (conditioning on the realized shocks in 2009-11) multiplier is estimated to be 1.3.Conditional on the sunspot equilibrium, the multipliers are generally smaller and the scope for conventional expansionary monetary policy is severely limited.

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References

2004Interest and Prices 2011When Is the Government Spending Multiplier Large?2003Zero Bound on Interest Rates and Optimal Monetary Policy 2007Bayesian Analysis of DSGE Models 2003The Zero Bound on Interest Rates and Optimal Monetary Policy 2001The Perils of Taylor Rules 2011What Fiscal Policy Is Effective at Zero Interest Rates?1992Projection methods for solving aggregate growth models

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