Work

Could an economy get stuck on a rational pessimism sunspot path? The case of Japan

Year: 2025

Type: article

Abstract: Developed economies have experienced slower growth since the 2008 financial crisis, creating fears of “secular stagnation.” Rational expectations models have forward-looking sunspot solutions, which could cause this; here we investigate the case of Japan. We show that a New Keynesian model with a weak equilibrium growth path driven by pessimism sunspot belief shocks matches Japanese economic behaviour. Another possibility is a conventional model where productivity growth has simply slowed down for unknown reasons. Nevertheless, a welfare-optimising approach implies fiscal policy should commit to eliminating the potential sunspot while being prepared to revert to normal policy if inflation rises. • We develop a model with weak equilibrium growth driven by pessimism sunspot shocks. • Estimated and tested by Indirect Inference to match Japanese economic behaviour. • Welfare optimisation shows fiscal policy should commit to eliminating the sunspot.

Source: Journal of International Financial Markets Institutions and Money

DOI: 10.1016/j.intfin.2025.102142

Authors: Vo Phuong Mai Le, David Meenagh, Patrick Minford

Institutions: Cardiff University, Centre for Economic Policy Research

Language: English

Topic: Monetary Policy and Economic Impact

Subfield: General Economics, Econometrics and Finance

Field: Economics, Econometrics and Finance

Domain: Social Sciences

SDG: Decent work and economic growth

Open Access status: hybrid

Estimated APC paid: $2,930