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Cooperative Fiscal Policy at the Zero Lower Bound

In: Fiscal Policy and Crisis

Author

Listed:
  • David Cook
  • Michael B. Devereux

Abstract

This paper investigates the use of fiscal policy in response to a large negative aggregate demand shock which may push the global economy into a liquidity trap. Fiscal policy may be an effective tool to respond to a liquidity trap, but its international spillover effects may operate quite differently from its domestic effects. We derive the optimal cooperative fiscal response to a global liquidity trap in a two country world economy. Surprisingly, we find that the optimal fiscal spending response for a partner country to a negative aggregate demand shock in a source country may be negative. If fiscal policy can be chosen under policy commitment, the optimal response involves current fiscal expansion combined with future fiscal contraction, after the liquidity trap has ended.
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Suggested Citation

  • David Cook & Michael B. Devereux, 2010. "Cooperative Fiscal Policy at the Zero Lower Bound," NBER Chapters, in: Fiscal Policy and Crisis, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberch:12701
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    2. David Cook & Michael B Devereux, 2019. "Fiscal Policy in a Currency Union at the Zero Lower Bound," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 51(S1), pages 43-82, December.

    More about this item

    JEL classification:

    • E2 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook

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