Unique Equilibrium in a Model of Secular Stagnation∗

TLDR: In this article , the authors develop an endogenous equilibrium-selection mechanism by integrating a global-game approach into a secular-stagnation model, which generates strategic complementarity in households' decision-making, resulting in a unique equilibrium choice.

Abstract: In secular-stagnation models, multiple equilibria can arise, implying that monetary policy may not be able to achieve an inflation target even when the target is sufficiently high and the government is perfectly credible. Under perfect information about fundamentals, a unique equilibrium cannot be pinned down because agents’ beliefs are perfectly coordinated. I relax the assumption of perfect information and develop an endogenous equilibrium-selection mechanism by integrating a global-game approach into a secular-stagnation model, which generates strategic complementarity in households’ decision-making,"my action depends on my belief of your action", resulting in a unique equilibrium choice. In contrast to the existing literature on Secular Stagnation, I find that given an inflation target, a temporary fiscal expansion or an average-inflation-targeting policy (AIT) can raise the likelihood that a better equilibrium is chosen by reinforcing strategic complementarity, which promotes households’ ability to coordinate to resolve the demand shortage. In a calibrating example, I find that the selection probability of a secular-stagnation equilibrium was high in the US after the Great Recession but more fiscal expansion and AIT reduced it.