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Optimal fiscal and monetary policy with occasionally binding zero bound constraints |
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| Affiliation: | 1. Policy Research Institute, Ministry of Finance, 3-1-1 Kasumigaseki, Chiyoda-ku, Tokyo 100-8940, Japan;2. Institute of Innovation Research, Hitotsubashi University, 2-1 Naka, Kunitachi, Tokyo 186-8603, Japan;3. Department of Economics, Shinshu University, 3-1-1 Asahi, Matsumoto, Nagano 390-0802, Japan;1. Duke University, 213 Social Sciences Building, Box 90097, Durham, NC 27708, USA;2. NBER, 1050 Massachusetts Ave., Cambridge, MA 02138, USA;3. CEPR, 33 Great Sutton Street, London EC1V 0DX, United Kingdom;1. Federal Reserve Bank of San Francisco, 101 Market Street, MS 1130, San Francisco, CA94105, United States;2. Columbia University, United States;1. Office of Financial Stability, Federal Reserve Board, 20th and C Streets NW, Washington, DC 20551, United States;2. Division of International Finance, Federal Reserve Board, 20th and C Streets NW, Washington, DC 20551, United States |
| Abstract: | This paper studies optimal fiscal and monetary policy when the nominal interest rate is subject to the zero lower bound (ZLB) constraint in a stochastic New Keynesian economy. In the baseline model calibrated to match key features of the U.S. economy, it is optimal for the government to increase its spending when at the ZLB in the stochastic environment by about 60 percent more 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 ZLB. |
| Keywords: | Fiscal policy Government spending Markov-perfect policy Occasionally binding constraints Time-inconsistency Zero lower bound |
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