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Optimal fiscal and monetary policy with occasionally binding zero bound constraints

Listed author(s):
  • Taisuke Nakata

This paper studies optimal government spending and monetary policy when the nominal interest rate is subject to the zero lower bound constraint in a stochastic New Keynesian economy. I find that the government chooses to increase its spending when at the zero lower bound by a substantially larger amount in the stochastic environment than it would in the deterministic environment. The presence of uncertainty creates a unique time-consistency problem if the steady-state is inefficient. Although access to government spending policy increases welfare in the face of a large deflationary shock, it decreases welfare during normal times as the government reduces the nominal interest rate less aggressively before reaching the zero lower bound

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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2013-40.

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Date of creation: 2013
Handle: RePEc:fip:fedgfe:2013-40
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