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Fiscal and monetary policy interactions in a low interest rate world

Boris Hofmann (), Marco Lombardi (), Benoit Mojon () and Athanasios Orphanides ()

No 954, BIS Working Papers from Bank for International Settlements

Abstract: We analyse fiscal and monetary policy interactions when interest rate policy is hampered by the zero lower bound (ZLB) in an environment where expectations are formed with perpetual learning. The ZLB induces a deterioration of economic performance and raises the risk of persistent low ation that can disanchor in ation expectations and lead to debt de ation. Systematic use of quantitative easing (QE) can partially substitute for interest rate easing and, if sufficiently aggressive, can maintain average in ation in line with the central bank's goal. By compressing term premia on longterm interest rates, QE creates fiscal space that facilitates expansionary fiscal policy and reduces debt-de ation risk. The ZLB can be counteracted with less aggressive QE if mildly negative policy rates are feasible, if more countercyclical fiscal policy can be activated, or if the central bank can credibly communicate a clear in ation goal. Timidity in implementing QE and excessively debt-averse fiscal policies are counterproductive.

Keywords: zero lower bound; fiscal policy; debt de ation; quantitative easing; perpetual learning (search for similar items in EconPapers)
JEL-codes: E52 E58 E62 E63 (search for similar items in EconPapers)
Pages: 51 pages
Date: 2021-07
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
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