Stagnation traps
Gianluca Benigno and Luca Fornaro. December 2015
Thursday 14 April 2016, by Carlos San Juan
We provide a Keynesian growth theory in which pessimistic expectations can lead to very
persistent, or even permanent, slumps characterized by 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 interest rate
against the zero lower bound, while growth is weak because low aggregate demand results in
low profits, limiting firms’ investment in innovation. Policies aiming at restoring growth can
successfully lead the economy out of a stagnation trap, thus rationalizing the notion of job
creating growth.