Dealing with a liquidity trap when government debt matters: Optimal time-consistent monetary and fiscal policy

Matthias Burgert and Sebastian Schmidt

Journal of Economic Dynamics and Control, 2014, vol. 47, issue C, 282-299

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. 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.

Keywords: Monetary policy; Fiscal policy; Deficit spending; Discretion; Zero nominal interest rate bound (search for similar items in EconPapers)
JEL-codes: D11 E31 E52 E62 E63 (search for similar items in EconPapers)
Date: 2014
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (35)

Downloads: (external link)
http://www.sciencedirect.com/science/article/pii/S0165188914002073
Full text for ScienceDirect subscribers only

Related works:
Working Paper: 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)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:47:y:2014:i:c:p:282-299

DOI: 10.1016/j.jedc.2014.08.018

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
Bibliographic data for series maintained by Catherine Liu ().