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Monetary and Fiscal Policy in a Liquidity Trap with Inflation Persistence

Author

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  • Jean-Baptiste Michau

    (X-DEP-ECO - Département d'Économie de l'École Polytechnique - X - École polytechnique - IP Paris - Institut Polytechnique de Paris)

Abstract

This paper relies on the new Keynesian model with inflation persistence to characterize the optimal monetary and fiscal policy in a liquidity trap. It shows that, with a Phillips curve that is both forward and backward looking, the monetary policy that is implemented during a liquidity trap episode can lift the economy out of depression. The central bank does not need to commit beyond the end of the crisis to get some traction on the level of economic activity. Regarding fiscal policy, inflation persistence justifies some front-loading of government expenditures to get ination started, which reduces the real interest rate. The magnitude of the optimal fiscal stimulus is decreasing in the degree of inflation persistence. Finally, if inflation persistence is due to adaptive expectations, rather than to price indexation, then monetary policy is ineffective while the optimal fiscal stimulus is large and heavily front-loaded.

Suggested Citation

  • Jean-Baptiste Michau, 2014. "Monetary and Fiscal Policy in a Liquidity Trap with Inflation Persistence," Working Papers hal-01089192, HAL.
    • Handle: RePEc:hal:wpaper:hal-01089192
    Note: View the original document on HAL open archive server: https://hal.science/hal-01089192
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    References listed on IDEAS

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    Cited by:

    1. Roulleau-Pasdeloup, Jordan, 2020. "Optimal monetary policy and determinacy under active/passive regimes," European Economic Review, Elsevier, vol. 130(C).
    2. Kohei Hasui & Tomohiro Sugo & Yuki Teranishi, 2024. "Liquidity Trap and Optimal Monetary Policy: Evaluations for U.S. Monetary Policy," Working Papers on Central Bank Communication 051, University of Tokyo, Graduate School of Economics.
    3. Kohei Hasui & Yuki Teranishi, 2024. "Optimal Monetary Policy in a Liquidity Trap: Evaluations for Japan’s Monetary Policy," Working Papers on Central Bank Communication 050, University of Tokyo, Graduate School of Economics.

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    More about this item

    Keywords

    Commitment; Inflation persistence; Liquidity trap; Monetary and fiscal policy JEL Classification: E12; E52; E62; E63;
    All these keywords.

    JEL classification:

    • E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian; Modern Monetary Theory
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy

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