Dynamic Debt Deleveraging and Optimal Monetary Policy
48 Pages Posted: 6 Oct 2014
Date Written: October 2014
This paper studies optimal monetary policy under dynamic debt deleveraging once the zero bound is binding. Unlike the existing literature, the natural rate of interest is endogenous and depends on macroeconomic policy. Optimal monetary policy successfully raises the natural rate of interest by creating an environment that speeds up deleveraging, thus endogenously shortening the duration of the crisis and a binding zero bound. Inflation should be front loaded. Fiscal-policy multipliers can be even higher than in existing models, but depend on the way in which public spending is financed.
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