Fiscal Multipliers at the Zero Lower Bound: The Role of Policy Inertia
44 Pages Posted: 4 Jan 2015
Date Written: December 19, 2014
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: Suggested Citation