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Countercyclical fiscal policy in a low r∗ world

Author

Listed:
  • Alisdair McKay

    (Boston University)

  • Ricardo Reis

    (London School of Economics)

Abstract

If the natural rate of interest is lower in the future, monetary policy may be more constrained and discretionary fiscal policy may come with larger multipliers. Does this imply that countercyclical fiscal policy should be more active, or that there should be a larger role for automatic stabilizers? This paper investigates if this is so by analyzing a business cycle model with heterogeneous agents and nominal rigidities, which frequently hits the zero lower bound. If markets are complete, then fiscal policy should be more active in a low r∗ world only if its precision is large enough. If markets are incomplete, there may be a tradeoff between more active policy or more aggressive automatic stabilizers. We quantify these effects in a model calibrated to the U.S. economy.

Suggested Citation

  • Alisdair McKay & Ricardo Reis, 2018. "Countercyclical fiscal policy in a low r∗ world," 2018 Meeting Papers 621, Society for Economic Dynamics.
    • Handle: RePEc:red:sed018:621
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