Fiscal Origins of Monetary Paradoxes

We revisit the monetary paradoxes of standard monetary models in a liquidity trap and study the channels through which they occur. We focus on two paradoxes: the Forward Guidance Puzzle and the Para- dox of Flexibility. First, we propose a decomposition of consumption into substitution and wealth effects, both of which take into account the general equilibrium effects on output and ination, and we show that the substitution effect cannot account for the puzzles. Instead, mon- etary paradoxes are the result of strong wealth effects which, generi- cally, are solely determined by the expected scal response to the mon- etary shocks. We estimate the scal response to monetary policy shocks with US data and nd responses with the opposite sign to the ones im- plied by the standard equilibrium. Finally, we introduce the estimated scal responses into a medium-size DSGE model. We nd that the impulse-response of consumption and ination do not match the data, suggesting that wealth effects induced by scal policy may be impor- tant even outside of the liquidity trap. We show that models with con- strained agents can produce strong wealth effects if gross private debt is different than zero.