Expectations-Driven Liquidity Traps: Implications for Monetary and Fiscal Policy

We study optimal time-consistent monetary and fiscal policy in a New Keynesian model where occasional declines agents’ confidence give rise to persistent liquidity trap episodes. Insights from widely studied fundamental-driven traps are not useful guide for enhancing welfare this model. Raising the inflation target, appointing an inflation-conservative central banker, or allowing use of government spending as additional stabilization tool can exacerbate deflationary pressures demand deficiencies during However, policy-maker who is sufficiently less concerned with than society eliminates expectations-driven traps. (JEL E31, E52, E61, E62, E63)