Optimal Fiscal and Monetary Policy with Occasionally Binding Zero Bound Constraints
31 Pages Posted: 31 Jul 2013
Date Written: April 30, 2013
This paper studies optimal government spending and monetary policy when the nominal interest rate is subject to the zero lower bound constraint in a stochastic New Keynesian economy. I find that the government chooses to increase its spending when at the zero lower bound by a substantially larger amount in the stochastic environment than it would in the deterministic environment. The presence of uncertainty creates a unique time-consistency problem if the steady-state is inefficient. Although access to government spending policy increases welfare in the face of a large deflationary shock, it decreases welfare during normal times as the government reduces the nominal interest rate less aggressively before reaching the zero lower bound.
Keywords: Fiscal policy, government spending, occasionally binding constraints, liquidity trap, zero lower bound, Markov-perfect equilibria, commitment
JEL Classification: E32, E52, E61, E62, E63
Suggested Citation: Suggested Citation