Fiscal Activism and the Zero Nominal Interest Rate Bound

26 Pages Posted: 20 Mar 2014

Date Written: February 24, 2014

Abstract

I show that the zero nominal interest rate bound may render it desirable for society to appoint a fiscally activist policy-maker who cares less about the stabilisation of government spending relative to inflation and output gap stabilisation than the private sector does. I work with a simple New Keynesian model where the government has to decide each period afresh about the optimal level of public consumption and the one period nominal interest rate. A fiscally activist policy-maker uses government spending more aggressively to stabilise inflation and the output gap in a liquidity trap than an authority with preferences identical to those of society as a whole would do. The appointment of an activist policy-maker corrects for discretionary authorities’ disregard of the expectations channel, thereby reducing the welfare costs associated with zero bound events.

Keywords: monetary policy, fiscal policy, discretion, zero nominal interest rate bound

JEL Classification: 52, E62, E63

Suggested Citation

Schmidt, Sebastian, Fiscal Activism and the Zero Nominal Interest Rate Bound (February 24, 2014). ECB Working Paper No. 1653. Available at SSRN: https://ssrn.com/abstract=2400347

Sebastian Schmidt (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

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