Counter-Cyclical Fiscal Rules and the Zero Lower Bound

32 Pages Posted: 19 Aug 2022

See all articles by Sebastian Hauptmeier

Sebastian Hauptmeier

European Central Bank (ECB) - Directorate General Economics

Christophe Kamps

European Central Bank (ECB)

Lucas Arden

Deutsche Bundesbank

Date Written: August 1, 2022

Abstract

We analyse the effectiveness of optimal simple and implementable monetary and fiscal policy rules in stabilising economic activity, inflation and government debt in face of an occasionally binding lower bound on the nominal interest rate in a New Keynesian model. We show that, within the traditional assignment of active monetary policy and passive fiscal policy, the optimal fiscal policy rule features a strong counter-cyclical response to the deviation of inflation from the central bank’s target - providing significant macroeconomic stabilisation especially at the lower bound - while also featuring a strong response to government debt. Our quantitative results show that the optimal counter-cyclical fiscal feedback to inflation significantly improves welfare and reduces the lower-bound frequency. In addition, the optimal simple monetary and fiscal rules almost completely resolve the deflationary bias associated with the lower bound.

Keywords: deflationary bias, fiscal rules, inflation targeting, zero lower bound

JEL Classification: E31, E52, E61, E62

Suggested Citation

Hauptmeier, Sebastian and Kamps, Christophe and Arden, Lucas, Counter-Cyclical Fiscal Rules and the Zero Lower Bound (August 1, 2022). ECB Working Paper No. 2022/2715, Available at SSRN: https://ssrn.com/abstract=4194306 or http://dx.doi.org/10.2139/ssrn.4194306

Sebastian Hauptmeier (Contact Author)

European Central Bank (ECB) - Directorate General Economics ( email )

Kaiserstrasse 29
D-60311 Frankfurt am Main
Germany

Christophe Kamps

European Central Bank (ECB) ( email )

Sonnemannstrasse 20
D-60314 Frankfurt am Main
Germany

HOME PAGE: http://https://www.ecb.europa.eu/pub/research/authors/profiles/christophe-kamps.en.html

Lucas Arden

Deutsche Bundesbank ( email )

Wilhelm-Epstein-Str. 14
Frankfurt/Main, 60431
Germany

HOME PAGE: http://sites.google.com/view/lucasarden/home

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