Managing a Liquidity Trap: Monetary and Fiscal Policy
I study monetary and fiscal policy in liquidity trap scenario, where the zero bound on the nominal interest rate is initially binding. I adopt a continuous-time formulation of the standard New Keynesian model, which allows for an intuitive, graphical analysis and produces some novel results. Without commitment the economy suffers from deflation and depressed output. Perhaps counterintuitively, both are exacerbated with greater price flexibility. Turning to optimal monetary policy, I find that the interest rate should be kept at zero past the liquidity trap. I also show that inflation may be positive throughout. Thus, the absence of deflation is not evidence against a liquidity trap, but may actually be an optimal response to it. Output, on the other hand, always starts below its efficient level and rises above it. Finally, I study fiscal policy and show that, regardless of parameters that underlie estimated "multipliers", at the start of a liquidity trap spending be above its natural level. However, I also show that spending should declines and go below its natural level before returning to zero. I then decompose spending into its "opportunistic" and "stimulus" motives. The former is the optimal level of government purchases from a static, cost-benefit standpoint; the latter measures deviations from the former. I show that, at the start of a liquidity trap, optimal stimulus spending may be positive or negative.
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|Date of creation:||2011|
|Contact details of provider:|| Postal: Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA|
Web page: http://www.EconomicDynamics.org/
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- Adam, Klaus & Billi, Roberto M., 2006.
"Optimal Monetary Policy under Commitment with a Zero Bound on Nominal Interest Rates,"
Journal of Money, Credit and Banking,
Blackwell Publishing, vol. 38(7), pages 1877-1905, October.
- Adam, Klaus & Billi, Roberto M, 2003. "Optimal Monetary Policy Under Commitment with a Zero Bound on Nominal Interest Rates," CEPR Discussion Papers 4111, C.E.P.R. Discussion Papers.
- Roberto M. Billi & Klaus Adam, 2004. "Optimal Monetary Policy under Commitment with a Zero Bound on Nominal Interest Rates," Computing in Economics and Finance 2004 67, Society for Computational Economics.
- Klaus Adam & Roberto M. Billi, 2005. "Optimal monetary policy under commitment with a zero bound on nominal interest rates," Research Working Paper RWP 05-07, Federal Reserve Bank of Kansas City.
- Adam, Klaus & Billi, Roberto M., 2004. "Optimal monetary policy under commitment with a zero bound on nominal interest rates," CFS Working Paper Series 2004/13, Center for Financial Studies (CFS).
- Adam, Klaus & Billi, Roberto M., 2004. "Optimal monetary policy under commitment with a zero bound on nominal interest rates," Working Paper Series 377, European Central Bank.
- Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December.
- Richard Clarida & Jordi Galí & Mark Gertler, 1997. "The science of monetary policy: A new Keynesian perspective," Economics Working Papers 356, Department of Economics and Business, Universitat Pompeu Fabra, revised Apr 1999.
- Clarida, Richard & Galí, Jordi & Gertler, Mark, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," CEPR Discussion Papers 2139, C.E.P.R. Discussion Papers.
- Clarida, R. & Gali, J. & Gertler, M., 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Working Papers 99-13, C.V. Starr Center for Applied Economics, New York University.
- Richard Clarida & Jordi Gali & Mark Gertler, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," NBER Working Papers 7147, National Bureau of Economic Research, Inc.
- Lawrence Christiano & Martin Eichenbaum & Sergio Rebelo, 2011. "When Is the Government Spending Multiplier Large?," Journal of Political Economy, University of Chicago Press, vol. 119(1), pages 78-121.
- Lawrence Christiano & Martin Eichenbaum & Sergio Rebelo, 2009. "When is the government spending multiplier large?," NBER Working Papers 15394, National Bureau of Economic Research, Inc.
- Lawrence J. Christiano & Martin Eichenbaum & Sergio Rebelo, 2010. "When is the government spending multiplier large?," FRB Atlanta CQER Working Paper 2010-01, Federal Reserve Bank of Atlanta.
- 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.
- Olivier Blanchard & Giovanni Dell'Ariccia & Paolo Mauro, 2010. "Rethinking Macroeconomic Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 42(s1), pages 199-215, 09.
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