Working Paper

Optimal monetary and fiscal policy at the zero lower bound in a small open economy

Abstract: We investigate open economy dimensions of optimal monetary and fiscal policy at the zero lower bound (ZLB) in a small open economy model. At positive interest rates, the trade elasticity has negligible effects on optimal policy. In contrast, at the ZLB, the trade elasticity plays a key role in optimal policy prescriptions. The way in which the trade elasticity shapes policy depends on the government's ability to commit. Under discretion, the increase in government spending at the ZLB depends critically on the trade elasticity. Under commitment, the difference between future and current policies, both for domestic inflation and government spending, is smaller when the trade elasticity is higher.

JEL Classification: E31; E52; E58; E61; E62; E63; F41;

https://doi.org/10.24149/gwp260

Bibliographic Information

Provider: Federal Reserve Bank of Dallas

Part of Series: Globalization Institute Working Papers

Publication Date: 2016-01-01

Number: 260