European Economic Review (2008), Volumen 52, pages 1438-1463
We examine global economic dynamics under learning in a New Keynesian model in which the interest-rate rule is subject to the zero lower bound. Under normal monetary and ﬁscal policy, the intended steady state is locally but not globally stable. Large pessimistic shocks to expectations can lead to deﬂationary spirals with falling prices and falling output. To avoid this outcome we recommend augmenting normal policies with aggressive monetary and ﬁscal policy that guarantee a lower bound on inﬂation. In contrast, policies geared toward ensuring an output lower bound are insuﬃcient for avoiding deﬂationary spirals.