Achieving two policy targets with one policy instrument: heterogeneous expectations, countercyclical fiscal policy, and macroeconomic stabilization at the effective lower bound

Gilberto Lima, Mark Setterfield and Jaylson Silveira ()

No 2023_01, Working Papers, Department of Economics from University of São Paulo (FEA-USP)

Abstract: We explore the short-term macrodynamics of stabilization policy at the effective lower bound (ELB) of the nominal interest rate, in an environment characterized by heterogenous and endogenously time-varying private-sector output and inflation expectations driven by evolutionary dynamics. We show that at the ELB, fiscal policy conducted in accordance with a well-specified policy rule is particularly effective for purposes of macroeconomic stabilization. This is because fiscal interventions have both a direct effect on output and inflation (via aggregate demand formation) and an indirect effect on these same target variables, via the management of heterogenous and evolving expectations. As a result of the two channels through which it operates, and seemingly despite the logic of the Tinbergen (targets-instruments) principle, fiscal policy is thus revealed as a single policy instrument capable of achieving two policy goals.

Keywords: Stabilization policy; effective lower bound; fiscal policy; heterogeneous inflation and output expectations; satisficing evolutionary dynamics (search for similar items in EconPapers)
JEL-codes: E12 E52 E58 E62 E63 E71 (search for similar items in EconPapers)
Date: 2023-01-03
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Related works:
Working Paper: Achieving two policy targets with one policy instrument: heterogeneous expectations, countercyclical fiscal policy, and macroeconomic stabilization at the effective lower bound (2023)
Working Paper: Achieving two policy targets with one policy instrument: heterogeneous expectations, countercyclical fiscal policy, and macroeconomic stabilization at the effective lower bound (2023)
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