IDEAS home Printed from https://ideas.repec.org/p/chb/bcchwp/581.html
   My bibliography  Save this paper

Fiscal Deficits, Debt, and Monetary Policy in a Liquidity Trap

Author

Listed:
  • Michael Devereux

Abstract

The macroeconomic response to the economic crisis has revived old debates about the usefulness of monetary and fiscal policy in fighting recessions. Without the ability to further lower interest rates, policy authorities in many countries have turned to expansionary fiscal policies. Recent literature argues that government spending may be very effective in such environments. But a critical element of the stimulus packages in all countries was the use of deficit financing and tax reductions. This paper explores the role of government debt and deficits in an economy constrained by the zero bound on nominal interest rates. Given that the liquidity trap is generated by a large increase in the desire to save on the part of the private sector, the wealth effects of government deficits can provide a critical macroeconomic response to this. Government spending financed by deficits may be far more expansionary than that financed by tax increases in such an environment. In a liquidity trap, tax cuts may be much more effective than during normal times. Finally, monetary policies aimed at directly increasing monetary aggregates may be effective, even if interest rates are unchanged.

Suggested Citation

  • Michael Devereux, 2010. "Fiscal Deficits, Debt, and Monetary Policy in a Liquidity Trap," Working Papers Central Bank of Chile 581, Central Bank of Chile.
  • Handle: RePEc:chb:bcchwp:581
    as

    Download full text from publisher

    File URL: http://si2.bcentral.cl/public/pdf/documentos-trabajo/pdf/dtbc581.pdf
    Download Restriction: no

    Other versions of this item:

    References listed on IDEAS

    as
    1. Annicchiarico, Barbara & Giammarioli, Nicola & Piergallini, Alessandro, 2012. "Budgetary policies in a DSGE model with finite horizons," Research in Economics, Elsevier, vol. 66(2), pages 111-130.
    2. Jess Benhabib & Stephanie Schmitt-Grohe & Martin Uribe, 2002. "Avoiding Liquidity Traps," Journal of Political Economy, University of Chicago Press, vol. 110(3), pages 535-563, June.
    3. Olivier Jean Blanchard & Stanley Fischer, 1989. "Lectures on Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262022834, January.
    4. Jung, Taehun & Teranishi, Yuki & Watanabe, Tsutomu, 2005. "Optimal Monetary Policy at the Zero-Interest-Rate Bound," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 37(5), pages 813-835, October.
    5. Glenn D. Rudebusch, 2009. "The Fed's monetary policy response to the current crisis," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, issue may22.
    6. Evans, Paul, 1991. "Is Ricardian Equivalence a Good Approximation?," Economic Inquiry, Western Economic Association International, vol. 29(4), pages 626-644, October.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Annicchiarico, Barbara & Giammarioli, Nicola & Piergallini, Alessandro, 2012. "Budgetary policies in a DSGE model with finite horizons," Research in Economics, Elsevier, vol. 66(2), pages 111-130.
    2. Cook, David & Devereux, Michael B, 2016. "Exchange rate flexibility under the zero lower bound," Journal of International Economics, Elsevier, vol. 101(C), pages 52-69.

    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

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:chb:bcchwp:581. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Claudio Sepulveda). General contact details of provider: http://edirc.repec.org/data/bccgvcl.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.