Fiscal Multipliers at the Zero Lower Bound: The Role of Policy Inertia

44 Pages Posted: 4 Jan 2015

See all articles by Timothy Hills

Timothy Hills

New York University (NYU)

Taisuke Nakata

Board of Governors of the Federal Reserve System

Date Written: December 19, 2014

Abstract

The presence of the lagged shadow policy rate in the interest rate feedback rule reduces the government spending multiplier nontrivially when the policy rate is constrained at the zero lower bound (ZLB). In the economy with policy inertia, increased inflation and output due to higher government spending during a recession speed up the return of the policy rate to the steady state after the recession ends. This in turn dampens the expansionary effects of the government spending during the recession via expectations. In our baseline calibration, the output multiplier at the ZLB is 2.5 when the weight on the lagged shadow rate is zero, and 1.1 when the weight is 0.9.

Keywords: Fiscal Policy, Government Spending Multipliers, Interest Rate Smoothing, Liquidity Trap, Zero Lower Bound

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

Suggested Citation

Hills, Timothy and Nakata, Taisuke, Fiscal Multipliers at the Zero Lower Bound: The Role of Policy Inertia (December 19, 2014). FEDS Working Paper No. 2014-107. Available at SSRN: https://ssrn.com/abstract=2544659 or http://dx.doi.org/10.2139/ssrn.2544659

Timothy Hills

New York University (NYU) ( email )

Bobst Library, E-resource Acquisitions
20 Cooper Square 3rd Floor
New York, NY 10003-711
United States

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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