What fiscal policy is effective at zero interest rates?
AbstractTax cuts can deepen a recession if the short-term nominal interest rate is zero, according to a standard New Keynesian business cycle model. An example of a contractionary tax cut is a reduction in taxes on wages. This tax cut deepens a recession because it increases deflationary pressures. Another example is a cut in capital taxes. This tax cut deepens a recession because it encourages people to save instead of spend at a time when more spending is needed. Fiscal policies aimed directly at stimulating aggregate demand work better. These policies include 1) a temporary increase in government spending; and 2) tax cuts aimed directly at stimulating aggregate demand rather than aggregate supply, such as an investment tax credit or a cut in sales taxes. The results are specific to an environment in which the interest rate is close to zero, as observed in large parts of the world today.
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Bibliographic InfoPaper provided by Federal Reserve Bank of New York in its series Staff Reports with number 402.
Date of creation: 2009
Date of revision:
Other versions of this item:
- Gauti B. Eggertsson, 2011. "What Fiscal Policy is Effective at Zero Interest Rates?," NBER Chapters, in: NBER Macroeconomics Annual 2010, Volume 25, pages 59-112 National Bureau of Economic Research, Inc.
- NEP-ALL-2009-11-21 (All new papers)
- NEP-CBA-2009-11-21 (Central Banking)
- NEP-MAC-2009-11-21 (Macroeconomics)
- NEP-PBE-2009-11-21 (Public Economics)
- NEP-PUB-2009-11-21 (Public Finance)
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