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Macroeconomic Dynamics Near the ZLB: A Tale of Two Countries

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  • S Borağan Aruoba
  • Pablo Cuba-Borda
  • 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 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.

Suggested Citation

  • S Borağan Aruoba & Pablo Cuba-Borda & Frank Schorfheide, 2018. "Macroeconomic Dynamics Near the ZLB: A Tale of Two Countries," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 85(1), pages 87-118.
    • Handle: RePEc:oup:restud:v:85:y:2018:i:1:p:87-118.
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    File URL: https://hdl.handle.net/10.1093/restud/rdx027
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    More about this item

    Keywords

    Deflation; DSGE Models; Japan; Multiple Equilibria; Nonlinear Filtering; Nonlinear Solution Methods; Sunspots; U.S.; ZLB;
    All these keywords.

    JEL classification:

    • C5 - Mathematical and Quantitative Methods - - Econometric Modeling
    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit

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