Macroeconomic Dynamics Near the ZLB: A Tale of Two Equilibria

In addition to the standard targeted-inflation equilibrium, the authors consider a deflation equilibrium as well as a Markov sunspot equilibrium that switches between a targeted-inflation and a deflation regime. The authors use the particle filter to estimate the state of the U.S. economy during and after the 2008–09 recession under the assumptions that the U.S. economy has been in either the targeted-inflation or the sunspot equilibrium. The authors consider a combination of fiscal policy (calibrated to the American Recovery and Reinvestment Act) and monetary policy (that tries to keep interest rates near zero) and compute government spending multipliers. Ex-ante multipliers (cumulative over one year) under the targeted-inflation regime are around 0.9. A monetary policy that keeps interest rates at zero can raise the multiplier to 1.7. The ex-post (conditioning on the realized shocks in 2009–11) multiplier is estimated to be 1.3. Conditional on the sunspot equilibrium, the multipliers are generally smaller and the scope for conventional expansionary monetary policy is severely limited.