Self-fulfilling recessions at the zero lower bound

Abstract

We highlight an overlooked source of equilibrium multiplicity in monetary economies subject to a zero bound on nominal interest rates. In environments with sufficient endogenous propagation, depressed contemporary economic conditions must directly lower expectations of future output and inflation. A current recession followed by gradual convergence back to steady state may then be an equilibrium outcome, without any exogenous impulse. We present this mechanism heuristically in partial equilibrium, and in two computed examples of New Keynesian economies. Expansionary fiscal policy makes the recessionary equilibrium more severe at the margin, but commitment to a sufficiently large expansion can rule out multiplicity.