Macroeconomic Dynamics Near the ZLB: A Tale of Two Countries

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...

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Bibliographic Details
Published in:The Review of economic studies 2018-01, Vol.85 (1 (302)), p.87-118
Main Authors: ARUOBA, S. BORAĞAN, CUBA-BORDA, PABLO, SCHORFHEIDE, FRANK
Format: Article
Language:English
Subjects:
Aftermath
Central banks
Deflation
Equilibrium
Inflation rates
Interest rates
Specification
Stochastic models
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Summary: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 non-linear 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.
ISSN:0034-6527
1467-937X
DOI:10.1093/restud/rdx027