Fiscal stimulus in expectations-driven liquidity traps

Arbeitspapier

I study liquidity traps in a model where agents have heterogeneous expectations and finite planning horizons. Backward-looking agents base their expectations on past observations, while forward-looking agents have fully rational expectations. Liquidity traps that are fully or partly driven by expectations can arise due to pessimism of backward-looking agents. Only when planning horizons are finite, these liquidity traps can be of longer duration without ending up in a deflationary spiral. I further find that fiscal stimulus in the form of an increase in government spending or a cut in consumption taxes can be very effective in mitigating the liquidity trap. A feedback mechanism of heterogeneous expectations causes fiscal multipliers to be the largest when the majority of agents is backward-looking but there also is a considerable fraction of agents that are forward-looking. Labor tax cuts are always deflationary and are not an effective tool in a liquidity trap.

Object Details

• Language: Englisch

References and Relationships

• Bibliographic citation: Series: Discussion Paper Series ; No. 683

Classification and Topics

• Classification: Wirtschaft
• Subject: bounded rationality ; fiscal policy ; liquidity trap ; heterogeneous expectations

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): Lustenhouwer, Joep
• Event: Veröffentlichung
• (who): University of Heidelberg, Department of Economics
• (where): Heidelberg
• (when): 2020

Further information

• DOI: doi:10.11588/heidok.00028307
• Handle: http://hdl.handle.net/10419/235006
• URN: urn:nbn:de:bsz:16-heidok-283071
• Last update: 10.03.2025, 11:44 AM CET