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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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File URL: https://economicdynamics.org/meetpapers/2012/paper_181.pdf
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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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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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  1. 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.
  2. Anton Nakov, 2006. "Optimal and Simple Monetary Policy Rules with Zero Floor on the Nominal Interest Rate," Working Papers 0637, Banco de EspaƱa;Working Papers Homepage.
  3. 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.
  4. Taisuke Nakata, 2013. "Uncertainty at the Zero Lower Bound," 2013 Meeting Papers 924, Society for Economic Dynamics.
  5. Robert G. King & Alexander L. Wolman, 2003. "Monetary Discretion, Pricing Complementarity and Dynamic Multiple Equilibria," NBER Working Papers 9929, National Bureau of Economic Research, Inc.
  6. Taisuke Nakata, 2011. "Optimal Government Spending at the Zero Bound: Nonlinear and Non-Ricardian Analysis," 2011 Meeting Papers 831, Society for Economic Dynamics.
  7. Willem Van Zandweghe & Alexander L. Wolman, 2011. "Discretionary monetary policy in the Calvo model," Working Paper 11-03, Federal Reserve Bank of Richmond.
  8. Schmidt, Sebastian, 2012. "Optimal monetary and fiscal policy with a zero bound on nominal interest rates," IMFS Working Paper Series 53, Goethe University Frankfurt, Institute for Monetary and Financial Stability (IMFS).
  9. Martin, Fernando M., 2010. "Markov-perfect capital and labor taxes," Journal of Economic Dynamics and Control, Elsevier, vol. 34(3), pages 503-521, March.
  10. Roberto M. Billi, 2011. "Optimal Inflation for the US Economy," American Economic Journal: Macroeconomics, American Economic Association, vol. 3(3), pages 29-52, July.
  11. Robert G. King & Alexander L. Wolman, 2004. "Monetary Discretion, Pricing Complementarity, and Dynamic Multiple Equilibria," The Quarterly Journal of Economics, Oxford University Press, vol. 119(4), pages 1513-1553.
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