Working Paper

Macroeconomic Dynamics Near the ZLB : A Tale of Two Countries

Abstract: We compute a sunspot equilibrium in an estimated small-scale New Keynesian model with a zero lower bound (ZLB) constraint on nominal interest rates and a full set of stochastic fundamental shocks. In this equilibrium a sunspot shock can move the economy from a regime in which inflation is close to the central bank's target to a regime in which the central bank misses its target, inflation rates are negative, and interest rates are close to zero with high probability. A nonlinear filter is used to examine whether the U.S. in the aftermath of the Great Recession and Japan in the late 1990s transitioned to a deflation regime. The results are somewhat sensitive to the model specification, but on balance, the answer is affirmative for Japan and negative for the U.S.

Keywords: Deflation; DSGE Models; Japan; Multiple Equilibria; Nonlinear Filtering; Nonlinear Solution Methods; Sunspots; U.S.; zero lower bound (ZLB);

JEL Classification: C5; E4; E5;

https://doi.org/10.17016/IFDP.2016.1163

Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: International Finance Discussion Papers

Publication Date: 2016-05

Number: 1163

Pages: 47 pages