Fiscal Policy in an Expectations-Driven Liquidity Trap

We study the effects of fiscal policy interventions in a liquidity trap in a model with nominal rigidities and an interest rate rule. In a liquidity trap caused by a self-fulfilling state of low confidence, higher government spending has deflationary effects that reduce the spending multiplier when...

Full description

Saved in:
Bibliographic Details
Published inThe Review of economic studies Vol. 81; no. 4 (289); pp. 1637 - 1667
Main Authors MERTENS, KAREL R. S. M., RAVN, MORTEN O.
Format Journal Article
LanguageEnglish
Published Oxford Oxford University Press 01.10.2014
Subjects
Economic deflation
Economic expectations
Economic models
Fiscal policy
Government spending
Inflation rates
Interest rates
Liquidity
Liquidity trap
Monetary policy
Nominal interest rates
Public expenditure
Real interest rates
Studies
Tax rates
Online AccessGet full text

Cover

More Information
Summary:We study the effects of fiscal policy interventions in a liquidity trap in a model with nominal rigidities and an interest rate rule. In a liquidity trap caused by a self-fulfilling state of low confidence, higher government spending has deflationary effects that reduce the spending multiplier when the zero lower bound is binding. Instead, cuts in marginal labour tax rates are inflationary and become more expansionary when the zero lower bound is binding. These findings contradict a popular view, based on a liquidity trap caused by a fundamental shock such as a taste shock, that higher government spending is inflationary and can therefore be associated with large multipliers at the zero lower bound, while lower marginal tax rates are deflationary and therefore counterproductive.
Bibliography:ObjectType-Article-1
SourceType-Scholarly Journals-1
ObjectType-Feature-2
content type line 23
ISSN:0034-6527
1467-937X
DOI:10.1093/restud/rdu016