Expectations and the Zero Lower Bound

I consider the welfare consequences of information frictions at the zero lower bound. Households are assumed to know that interest rates are at zero, but have imperfect information about the precise state of the economy. I prove that this information friction acts like an actuarially fair insurance mechanism on the aggregate level. It therefore raises aggregate efficiency from an ex-ante perspective. The model matches output and inflation during the Great Recession, once one assumes that firms’ perceived persistence of the shock was low at the beginning of the Great Recession.

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