Policy multipliers under an interest rate peg of deterministic versus stochastic duration
AbstractThis paper revisits the size of the fiscal multiplier. The experiment is a fiscal expansion under the assumption of a pegged nominal rate of interest in linearised sticky price model. We demonstrate that a quantitatively important issue is the articulation of the exit from the policy experiment. If the monetary-fiscal expansion is stochastic with a mean duration of T periods, the fiscal multiplier can be unboundedly large. However, if the monetary-fiscal expansion is for fixed T periods, the multiplier is much smaller. Our explanation rests on a Jensen’s inequality-type argument: the deterministic multiplier is convex in duration, and the stochastic multiplier is a weighted average of the deterministic multipliers. The quantitative difference in the two multipliers also arises in a model with capital, and in the baseline non-linear model. However, the difference between the two is less pronounced in the non-linear models. The errors from a linear approximation are much larger for the stochastic exit model than for the deterministic exit model. Thus, we conclude that the deterministic exit model should be preferred.
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Bibliographic InfoPaper provided by Bank of England in its series Bank of England working papers with number 475.
Length: 23 pages
Date of creation: 14 Jun 2013
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Fiscal multiplier; fixed interest rates; New Keynesian model; zero lower bound;
Find related papers by JEL classification:
- E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
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