Is there a fiscal free lunch in a liquidity trap?

Christopher Erceg and Jesper Lindé

No 1003, International Finance Discussion Papers from Board of Governors of the Federal Reserve System (U.S.)

Abstract: This paper uses a DSGE model to examine the effects of an expansion in government spending in a liquidity trap. If the liquidity trap is very prolonged, the spending multiplier can be much larger than in normal circumstances, and the budgetary costs minimal. But given this \"fiscal free lunch,\" it is unclear why policymakers would want to limit the size of fiscal expansion. Our paper addresses this question in a model environment in which the duration of the liquidity trap is determined endogenously, and depends on the size of the fiscal stimulus. We show that even if the multiplier is high for small increases in government spending, it may decrease substantially at higher spending levels; thus, it is crucial to distinguish between the marginal and average responses of output and government debt.

Keywords: Monetary policy; Fiscal policy; Liquidity (Economics) (search for similar items in EconPapers)
Date: 2010
New Economics Papers: this item is included in nep-cba, nep-dge and nep-mac
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Citations: View citations in EconPapers (22)

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Related works:
Journal Article: IS THERE A FISCAL FREE LUNCH IN A LIQUIDITY TRAP? (2014)
Working Paper: Is There a Fiscal Free Lunch in a Liquidity Trap? (2010)
Working Paper: Is There a Fiscal Free Lunch in a Liquidity Trap? (2010)
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