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Time-Consistent Management of a Liquidity Trap with Government Debt

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  • Dmitry Matveev

    (Bank of Canada)

Abstract

This paper studies the effects of government debt under optimal discretionary monetary and fiscal policy when the lower bound on nominal interest rates is occasionally binding. This issue is addressed in a model with the labor income tax and long-term government debt. The risk of a binding lower bound reduces steady-state inflation. This causes an increase in government debt in the steady state. The debt increase and associated tax rate increase mitigate the reduction in inflation by raising the marginal cost of production. At the lower bound, given a fall in output, it is optimal for the government to temporarily reduce debt. This debt reduction stimulates output by lowering expected real interest rates following the liftoff of the nominal rate from the lower bound.

Suggested Citation

  • Dmitry Matveev, 2018. "Time-Consistent Management of a Liquidity Trap with Government Debt," 2018 Meeting Papers 310, Society for Economic Dynamics.
  • Handle: RePEc:red:sed018:310
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    References listed on IDEAS

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    1. Adam, Klaus & Billi, Roberto M., 2007. "Discretionary monetary policy and the zero lower bound on nominal interest rates," Journal of Monetary Economics, Elsevier, vol. 54(3), pages 728-752, April.
    2. Burgert, Matthias & Schmidt, Sebastian, 2014. "Dealing with a liquidity trap when government debt matters: Optimal time-consistent monetary and fiscal policy," Journal of Economic Dynamics and Control, Elsevier, vol. 47(C), pages 282-299.
    3. Gauti B. Eggertsson & Michael Woodford, 2006. "Optimal Monetary and Fiscal Policy in a Liquidity Trap," NBER Chapters, in: NBER International Seminar on Macroeconomics 2004, pages 75-144, National Bureau of Economic Research, Inc.
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    Cited by:

    1. Eric M Leeper & Campbell Leith & Ding Liu, 2016. "Optimal Time-Consistent Monetary, Fiscal and Debt Maturity Policy," Working Papers 2016_04, Business School - Economics, University of Glasgow.
    2. Taisuke Nakata, 2017. "Optimal Government Spending at the Zero Lower Bound: A Non-Ricardian Analysis," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 23, pages 150-169, January.
    3. Séverine Menguy, 2016. "Optimal Budgetary Policies in New-Keynesian Models: Can they help when the Zero Lower Bound is binding?," Bulletin of Applied Economics, Risk Market Journals, vol. 3(2), pages 43-98.
    4. Taisuke Nakata, 2017. "Optimal Government Spending at the Zero Lower Bound: A Non-Ricardian Analysis," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 23, pages 150-169, January.

    More about this item

    JEL classification:

    • 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
    • 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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