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Policy multipliers under an interest rate peg of deterministic versus stochastic duration

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  • Carlstrom, Chartles

    ()
    (Federal Reserve Bank of Cleveland)

  • Fuerst , Timothy

    ()
    (University of Notre Dame)

  • Paustian, Matthias

    ()
    (Bank of England)

Abstract

This 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 Info

Paper provided by Bank of England in its series Bank of England working papers with number 475.

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Length: 23 pages
Date of creation: 14 Jun 2013
Date of revision:
Handle: RePEc:boe:boeewp:0475

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Keywords: Fiscal multiplier; fixed interest rates; New Keynesian model; zero lower bound;

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  1. Lawrence J. Christiano & Martin Eichenbaum & Sergio Rebelo, 2010. "When is the government spending multiplier large?," CQER Working Paper 2010-01, Federal Reserve Bank of Atlanta.
  2. Gauti B. Eggertsson & Benjamin Pugsley, 2006. "The Mistake of 1937: A General Equilibrium Analysis," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 24(S1), pages 151-190, December.
  3. Michael Woodford, 2010. "Simple Analytics of the Government Expenditure Multiplier," Discussion Papers 0910-09, Columbia University, Department of Economics.
  4. Drautzburg, Thorsten & Uhlig, Harald, 2011. "Fiscal stimulus and distortionary taxation," ZEW Discussion Papers 11-037, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.
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