Fiscal Stimulus at the Zero Lower Bound: the role of expectations and policy coordination

In this article, we discuss the role expectations regarding future policies play in determining the depth of a crisis when the economy hits the zero lower bound on nominal interest rates. We show that when analyzing the impact of a fiscal stimulus during a zero interest rate episode, there is more than just short-run output multipliers. We extend the analysis in Eggertsson (2011) by allowing for a transitional state in which the zero lower bound is no longer binding, but policies can be expected to credibly deviate from their steady-state values. The main result of the paper is that, to have larger positive effects on output, monetary and fiscal policies should last longer than the duration of the shock and be coordinated. This coordination is required not only during the crisis but also in the commitment to future policy actions. It is fundamental to the fiscal authority to be able to respond quickly to the shock, minimizing implementation delays and correctly signaling the duration of the stimulus. We also show that a thoughtful evaluation of a fiscal stimulus in terms of the implied welfare losses should account not only for the effects of policies on short-run output and inflation, but also for the present discounted value of output and inflation in future periods as well.