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Understanding Persistent ZLB: Theory and Assessment

Sanjay R. Singh (UC Davis)
American Economic Journal: Macroeconomics (Conditionally Accepted).

Abstract

We develop a theoretical framework that rationalizes two hypotheses of long-lasting low-interest rate episodes: deflationary-expectations-traps and secular stagnation in a unified setting. These hypotheses differ in the sign of the theoretical correlation between inflation and output growth that they imply. Using the data from Japan over 1998:Q1-2019:Q4, we find that the data favor the expectations-trap hypothesis. The superior model fit of the expectations trap relies on its ability to generate the observed negative correlation between inflation and output growth.