 When is government debt accumulation optimal in a liquidity trap?Journal of Economic Dynamics and Control, 2023, vol. 147, issue C Abstract: When the government issues long-term bonds, the optimal time-consistent fiscal and monetary policy is to consolidate debt in a liquidity trap by increasing labor taxes aggressively. This prescription is at odds with large debt-financed fiscal expansions undertaken in the US during previous liquidity trap episodes. In this article, I show that accumulating debt turns optimal in a medium-scale model with sticky wages and limited asset market participation. In my model, the net disposable income of Rule-of-Thumb households is sensitive to tax variations and constitutes an additional constraint to fiscal policy. For plausible calibration, the discretionary policy maker chooses to curtail its tax increase and to beef up its spending stimulus. In long simulations, the volatility of taxes falls below the one of government spending, in line with empirical evidence. The debt increase in the liquidity trap is also consistent across maturities, both under discretion and commitment. Keywords: Optimal time-consistent policy; Distortionary taxation; Liquidity trap; Fiscal and monetary policy; Sticky wages; Rule-of-thumb consumers (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:147:y:2023:i:c:s0165188922002949 DOI: 10.1016/j.jedc.2022.104591 Access Statistics for this article Journal of Economic Dynamics and Control is currently edited by J. Bullard, C. Chiarella, H. Dawid, C. H. Hommes, P. Klein and C. Otrok More articles in Journal of Economic Dynamics and Control from Elsevier |
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