We study optimal monetary and fiscal policy in a New Keynesian model where occasional declines in agents' confidence can give rise to persistent liquidity trap episodes. Unlike in the case of fundamental-driven liquidity traps, there is no straightforward recipe for mitigating the welfare costs...

This paper analyzes the implications of a balanced-budget fiscal policy rule for price-level determination in a cash-in-advance economy under three alternative monetary policy regimes. It shows that the price level is indeterminate under a nominal interest rate peg and determinate under a money...

A key result of a recent literature that focuses on the global consequences of Taylor-type interest rate feedback rules is that such rules in combination with the zero bound on nominal interest rates can lead to unintended liquidity traps. An immediate question posed by this result is whether...

Once the zero bound on nominal interest rates is taken into account, Taylor-type interest-rate feedback rules give rise to unintended self-fulfilling decelerating inflation paths and aggregate fluctuations driven by arbitrary revisions in expectations. These undesirable equilibria exhibit the...