Policy multipliers under an interest rate peg of deterministic versus stochastic duration

Charles Carlstrom, Timothy Fuerst and Matthias Paustian ()
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Matthias Paustian: Bank of England, Postal: Publications Group Bank of England Threadneedle Street London EC2R 8AH

No 475, Bank of England working papers from Bank of England

Abstract: This paper revisits the size of the fiscal multiplier. The experiment is a fiscal expansion under the assumption of a pegged nominal rate of interest in linearised sticky price model. We demonstrate that a quantitatively important issue is the articulation of the exit from the policy experiment. If the monetary-fiscal expansion is stochastic with a mean duration of T periods, the fiscal multiplier can be unboundedly large. However, if the monetary-fiscal expansion is for fixed T periods, the multiplier is much smaller. Our explanation rests on a Jensen’s inequality-type argument: the deterministic multiplier is convex in duration, and the stochastic multiplier is a weighted average of the deterministic multipliers. The quantitative difference in the two multipliers also arises in a model with capital, and in the baseline non-linear model. However, the difference between the two is less pronounced in the non-linear models. The errors from a linear approximation are much larger for the stochastic exit model than for the deterministic exit model. Thus, we conclude that the deterministic exit model should be preferred.

Keywords: Fiscal multiplier; fixed interest rates; New Keynesian model; zero lower bound (search for similar items in EconPapers)
JEL-codes: E32 (search for similar items in EconPapers)
Pages: 23 pages
Date: 2013-06-14
New Economics Papers: this item is included in nep-mac
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:boe:boeewp:0475

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