Quantitative Easing and Fiscal Policy Effectiveness

Abstract

This paper studies the effects of fiscal policy on aggregate economic activity and inequality when the monetary authority follows conventional and unconventional policies. First, I build a three-agent Preferred Habitat New Keynesian (PHANK) model with a banking sector in which QE matters for the determination of output in the short run. I analytically derive the fiscal multiplier and show that it decreases in the presence of countercyclical QE policies, even at the zero lower bound. A calibration of the model for the US economy yields fiscal and QE multipliers close to 3 when the monetary authority pegs the short-term policy rate. The optimal fiscal and QE policies are expansionary at the ZLB. Second, I also consider a medium-scale HANK model to further study the distributional effects of fiscal expansions and recompute the fiscal multipliers under active fiscal policy, passive monetary policy and QE. In the enhanced model, the government spending multiplier at the ZLB is 1.041. Countercyclical QE after a fiscal expansion reduces consumption inequality in the medium run but increases wealth inequality. In the short-run those effects are reversed.

Keywords: Fiscal Multiplier, Fiscal Theory of the Price Level, Monetary Policy, Quantitative Easing, HANK, Inequality