The fear of persistent stagnation has never been greater in advanced economies as central banks continue to struggle with near-zero interest rates and low inflation. We theoretically explore issues of long-run stagnation in a representative agent framework. We analytically compare expectations-driven stagnation to a secular stagnation episode, and find contrasting policy implications for increase in government spending, nominal interest rates and positive supply shocks. For example, government spending is expansionary during secular stagnation but contractionary in an expectations-driven trap. In an estimated DSGE model, we find that Japan’s prolonged stagnation could be explained by both hypothesis, but the transmission of shocks differs markedly.
Updated draft coming soon.