Optimal Fiscal and Monetary Policy with Occasionally Binding Zero Bound Constraints

31 Pages Posted: 31 Jul 2013

See all articles by Taisuke Nakata

Taisuke Nakata

Board of Governors of the Federal Reserve System

Date Written: April 30, 2013

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.

Keywords: Fiscal policy, government spending, occasionally binding constraints, liquidity trap, zero lower bound, Markov-perfect equilibria, commitment

JEL Classification: E32, E52, E61, E62, E63

Suggested Citation

Nakata, Taisuke, Optimal Fiscal and Monetary Policy with Occasionally Binding Zero Bound Constraints (April 30, 2013). FEDS Working Paper No. 2013-40. Available at SSRN: https://ssrn.com/abstract=2303884 or http://dx.doi.org/10.2139/ssrn.2303884

Taisuke Nakata (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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