Fiscal Policy under Secular Stagnation: An Optimal Pump Priming Strategy

Jean-Baptiste Michau

No 2020-14, Working Papers from Center for Research in Economics and Statistics

Abstract: This paper provides a new perspective on …scal policy. A permanent depression in aggregate demand results in multiple equilibria: a secular stagnation equilibrium characterized by a binding zero lower bound, low in‡ation, and underemployment; and a neoclassical equilibrium where in‡ation is su¢ ciently high for the zero lower bound to be non-binding at the (very low) natural real interest rate, resulting in full employment. The optimal …scal policy under secular stagnation consists in moving the economy to the neoclassical equilibrium. This requires a temporary, but massive, amount of government spending to overheat the economy such as to raise the in‡ation anchor. The lack of …scal space cannot prevent the government from pump priming the economy through …scal policy. It may in fact help spur in‡ation. To keep a tight control over the price level, the government can …nance the stimulus through a sufficiently long maturity structure of government debt.

Keywords: Fiscal policy; Liquidity trap; Ponzi scheme; Secular stagnation. (search for similar items in EconPapers)
JEL-codes: E12 E62 E63 H63 (search for similar items in EconPapers)
Pages: 57 pages
Date: 2020-06-12
New Economics Papers: this item is included in nep-mac
References: View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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