Working Paper

Optimal fiscal and monetary policy with occasionally binding zero bound constraints

Abstract: 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 New Keynesian economy. I find that the government chooses to increase its spending when at the zero lower bound by a substantially larger amount in the stochastic environment than it would in the deterministic environment. The presence of uncertainty creates a unique time-consistency problem if the steady-state is inefficient. Although access to government spending policy increases welfare in the face of a large deflationary shock, it decreases welfare during normal times as the government reduces the nominal interest rate less aggressively before reaching the zero lower bound

Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: Finance and Economics Discussion Series

Publication Date: 2013

Number: 2013-40