American Economic Review
ISSN 0002-8282 (Print) | ISSN 1944-7981 (Online)
Are Low Interest Rates Deflationary? A Paradox of Perfect-Foresight Analysis
American Economic Review
(pp. 86–120)
Abstract
We argue that an influential "neo-Fisherian" analysis of the effects of low interest rates depends on using perfect foresight equilibrium analysis under circumstances where it is not plausible for people to hold expectations of that kind. We propose an explicit cognitive process by which agents may form their expectations of future endogenous variables. Perfect foresight is justified by our analysis as a reasonable approximation in some cases, but in the case of a commitment to maintain a low nominal interest rate for a long time, our reflective equilibrium implies neither neo-Fisherian conclusions nor implausibly strong predicted effects of forward guidance.Citation
García-Schmidt, Mariana, and Michael Woodford. 2019. "Are Low Interest Rates Deflationary? A Paradox of Perfect-Foresight Analysis." American Economic Review 109 (1): 86–120. DOI: 10.1257/aer.20170110Additional Materials
JEL Classification
- D84 Expectations; Speculations
- E12 General Aggregative Models: Keynes; Keynesian; Post-Keynesian
- E31 Price Level; Inflation; Deflation
- E43 Interest Rates: Determination, Term Structure, and Effects
- E52 Monetary Policy