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Optimal Fiscal and Monetary Policy with Occasionally Binding Zero Bound Constraints

  • Taisuke Nakata

    (New York University)

During the Great Recession, the government provided large fiscal stimulus in an economic environment characterized by a high degree of uncertainty on the future course of the economy while the nominal interest rate was constrained at the zero lower bound. While many papers have analyzed the effects of fiscal policy at the zero lower bound, they all do so in a deterministic environment. 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 environment. In the presence of uncertainty, the government chooses to increase its spending when at the zero lower bound by a substantially larger amount than it would in the deterministic environment. The welfare effect of fiscal policy is nuanced in the stochastic environment if the government cannot commit. Although the access to government spending policy increases welfare in the face of a large deflationary shock, it can decrease 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 Society for Economic Dynamics in its series 2012 Meeting Papers with number 181.

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Date of creation: 2012
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Handle: RePEc:red:sed012:181
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  1. Schmidt, Sebastian, 2012. "Optimal monetary and fiscal policy with a zero bound on nominal interest rates," IMFS Working Paper Series 53, Institute for Monetary and Financial Stability (IMFS), Goethe University Frankfurt.
  2. Olivier Coibion & Yuriy Gorodnichenko & Johannes Wieland, 2010. "The Optimal Inflation Rate in New Keynesian Models," Working Papers 91, Department of Economics, College of William and Mary.
  3. Martin, Fernando M., 2010. "Markov-perfect capital and labor taxes," Journal of Economic Dynamics and Control, Elsevier, vol. 34(3), pages 503-521, March.
  4. Robert G. King & Alexander L. Wolman, 2004. "Monetary Discretion, Pricing Complementarity, and Dynamic Multiple Equilibria," The Quarterly Journal of Economics, MIT Press, vol. 119(4), pages 1513-1553, November.
  5. Eric Swanson & Gauti Eggertsson, 2007. "Optimal Time-Consistent Monetary Policy in the New Keynesian Model with Repeated Simultaneous Play," 2007 Meeting Papers 214, Society for Economic Dynamics.
  6. Taisuke Nakata, 2013. "Uncertainty at the Zero Lower Bound," 2013 Meeting Papers 924, Society for Economic Dynamics.
  7. Lawrence Christiano & Martin Eichenbaum & Sergio Rebelo, 2009. "When is the government spending multiplier large?," NBER Working Papers 15394, National Bureau of Economic Research, Inc.
  8. 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.
  9. Willem Van Zandweghe & Alexander L. Wolman, 2010. "Discretionary monetary policy in the Calvo model," Research Working Paper RWP 10-06, Federal Reserve Bank of Kansas City.
  10. Michelle Alexopoulos & Jon Cohen, 2009. "Uncertain Times, uncertain measures," Working Papers tecipa-352, University of Toronto, Department of Economics.
  11. Roberto M. Billi, 2011. "Optimal Inflation for the US Economy," American Economic Journal: Macroeconomics, American Economic Association, vol. 3(3), pages 29-52, July.
  12. Anton Nakov, 2008. "Optimal and Simple Monetary Policy Rules with Zero Floor on the Nominal Interest Rate," International Journal of Central Banking, International Journal of Central Banking, vol. 4(2), pages 73-127, June.
  13. Taisuke Nakata, 2011. "Optimal Government Spending at the Zero Bound: Nonlinear and Non-Ricardian Analysis," 2011 Meeting Papers 831, Society for Economic Dynamics.
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