Time-Consistent Management of a Liquidity Trap with Government Debt

Dmitry Matveev

No 310, 2018 Meeting Papers from Society for Economic Dynamics

Abstract: This paper studies the effects of government debt under optimal discretionary monetary and fiscal policy when the lower bound on nominal interest rates is occasionally binding. This issue is addressed in a model with the labor income tax and long-term government debt. The risk of a binding lower bound reduces steady-state inflation. This causes an increase in government debt in the steady state. The debt increase and associated tax rate increase mitigate the reduction in inflation by raising the marginal cost of production. At the lower bound, given a fall in output, it is optimal for the government to temporarily reduce debt. This debt reduction stimulates output by lowering expected real interest rates following the liftoff of the nominal rate from the lower bound.

Date: 2018
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-mon
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Working Paper: Time-Consistent Management of a Liquidity Trap with Government Debt (2018)
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed018:310

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