Stagnation Traps

Recognition Program

Authors: Gianluca Benigno and Luca Fornaro

Review of Economic Studies, Vol. 85 , No 3, 1425-1470, July, 2018

We provide a Keynesian growth theory in which pessimistic expectations can lead to very persistent, or even permanent, slumps characterized by high unemployment and weak growth. We refer to these episodes as stagnation traps, because they consist in the joint occurrence of a liquidity and a growth trap. In a stagnation trap, the central bank is unable to restore full employment because weak growth depresses aggregate demand and pushes the policy rate against the zero lower bound, while growth is weak because low aggregate demand results in low profits, limiting firms' investment in innovation. Aggressive policies aiming at restoring growth, such as subsidies to investment, can successfully lead the economy out of a stagnation trap by generating a regime shift in agents' growth expectations.

This paper originally appeared as Barcelona School of Economics Working Paper 832
This paper is acknowledged by the Barcelona School of Economics Recognition Program