International Finance Discussion Papers (IFDP)

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May 2016

Macroeconomic Dynamics Near the ZLB: A Tale of Two Countries

S. Boragan Aruoba, Pablo Cuba-Borda, and Frank Schorfheide

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., ZLB

DOI: http://dx.doi.org/10.17016/IFDP.2016.1163

PDF: Full Paper

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Last Update: June 19, 2020