Dealing with a Liquidity Trap when Government Debt Matters: Optimal Time-Consistent Monetary and Fiscal Policy

Matthias Burgert and Sebastian Schmidt

VfS Annual Conference 2014 (Hamburg): Evidence-based Economic Policy from Verein für Socialpolitik / German Economic Association

Abstract: How does the need to preserve government debt sustainability affect the optimal monetary and fiscal policy response to a liquidity trap? To provide an answer, we employ a small stochastic New Keynesian model with a zero bound on nominal interest rates and characterize optimal time-consistent stabilization policies. We focus on two policy tools, the short-term nominal interest rate and debt-financed government spending. The optimal policy response to a liquidity trap critically depends on the prevailing debt burden. In our model, while the optimal amount of government spending is decreasing in the level of outstanding government debt, future monetary policy is becoming more accommodative, triggering a change in private sector expectations that helps to dampen the fall in output and inflation at the outset of the liquidity trap.

JEL-codes: D11 E31 E63 (search for similar items in EconPapers)
Date: 2014
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
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Citations: View citations in EconPapers (34)

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Related works:
Journal Article: Dealing with a liquidity trap when government debt matters: Optimal time-consistent monetary and fiscal policy (2014)
Working Paper: Dealing with a liquidity trap when government debt matters: optimal time-consistent monetary and fiscal policy (2013)
Working Paper: Dealing with a liquidity trap when government debt matters: Optimal time-consistent monetary and fiscal policy (2013)
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:vfsc14:100451

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