Monetary and fiscal policy design at the zero lower nound - Evidence from the Lab

The global economic crisis of 2007-8 pushed many advanced economies into a liquidity trap, a macroeconomic scenario characterised by nomial rates at the zero lower bound (ZLB), low inflation and output below trend. We design an experiment to generate empirical evidence on the effectiveness of policies aimed at managing expectations against liquidity traps in a controlled laboratory environment where expectations are elicied directly from human subjects. Our results suggest that monetary policy alone is not sufficient to insulate the economy form the risk of falling into a liquidity trap, even if it preventively cuts the policy augmented with a fiscal switching rule succeeds in avoiding and escapiing liquidity trap episodes. We also measure larger-than-unity fiscal mulipliers when monetary policy is constrained by the ZLB. Experimental results in different treatments are well explained by adaptive learning.