Expectations, Stagnation and Fiscal Policy: a Nonlinear Analysis

Stagnation and fiscal policy are examined in a nonlinear stochastic New-Keynesian model withadaptive learning. There are three steady states. The steady state targeted by policy is locally butnot globally stable under learning. A severe pessimistic expectations shock can trap the economyin a stagnation regime, underpinned by a low-level steady state, with falling inflation and output. Alarge fiscal stimulus may be needed to avoid or emerge from stagnation, and the impacts offorward guidance, credit frictions, central bank credibility and policy delay are studied. Our modelencompasses a wide range of outcomes arising from pessimistic expectations shocks.