Countercyclical fiscal policy in a low r∗ world

Alisdair McKay and Ricardo Reis
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Ricardo Reis: London School of Economics

No 621, 2018 Meeting Papers from Society for Economic Dynamics

Abstract: If the natural rate of interest is lower in the future, monetary policy may be more constrained and discretionary fiscal policy may come with larger multipliers. Does this imply that countercyclical fiscal policy should be more active, or that there should be a larger role for automatic stabilizers? This paper investigates if this is so by analyzing a business cycle model with heterogeneous agents and nominal rigidities, which frequently hits the zero lower bound. If markets are complete, then fiscal policy should be more active in a low r∗ world only if its precision is large enough. If markets are incomplete, there may be a tradeoff between more active policy or more aggressive automatic stabilizers. We quantify these effects in a model calibrated to the U.S. economy.

Date: 2018
New Economics Papers: this item is included in nep-dge and nep-mac
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed018:621

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