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

Matthias Burgert and Sebastian Schmidt

No 1622, Working Paper Series from European Central Bank

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 Classification: E31, E52, E62, E63, D11

Keywords: deficit spending; discretion; monetary and fiscal policy; new Keynesian model; zero nominal interest rate bound (search for similar items in EconPapers)
Date: 2013-12
New Economics Papers: this item is included in nep-cba, nep-mac, nep-mon and nep-pbe
Note: 2179645
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

Downloads: (external link)
https://www.ecb.europa.eu//pub/pdf/scpwps/ecbwp1622.pdf (application/pdf)

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 (2014)
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:ecb:ecbwps:20131622

Access Statistics for this paper

More papers in Working Paper Series from European Central Bank 60640 Frankfurt am Main, Germany. Contact information at EDIRC.
Bibliographic data for series maintained by Official Publications ().