Expectations and Policies in Deflationary Recessions

In this paper, we use a non†tA¢tonnement dynamic macroeconomic model to study the role of inventories, expectations and wages in the business cycle. Following a restrictive monetary shock, by amplifying spillover effects inventories may imply that the economy converges to a deflationary locally stable Keynesian underemployment state. The model is applied to evaluate economic policies like quantitative easing as well as the effectiveness of holding inflationary expectations to recover to full employment. If inflationary expectations are not sufficient, imposing downward rigidity of nominal wages helps to exit from the recession.