Journal
JOURNAL OF MONETARY ECONOMICS
Volume 104, Issue -, Pages 1-22Publisher
ELSEVIER SCIENCE BV
DOI: 10.1016/j.jmoneco.2018.09.001
Keywords
Monetary and fiscal policies; Coordination; Emergency budget; Markov-switching models; Liquidity traps welfare; Uncertainty
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If the government's willingness to stabilize debt is waning, while the central bank is adamant about keeping inflation low, the economy enters a vicious spiral of higher inflation, monetary tightening, recession, and further debt accumulation. The mere possibility of this conflict represents a drag on the economy. A commitment to inflate away the debt accumulated during a large recession leads to welfare improvements and lower uncertainty by separating long-run fiscal sustainability from the short-run fiscal stimulus. This strategy can be used to avoid the zero lower bound. As a technical contribution, we explain how to build shock-specific policy rules. (C) 2018 Elsevier B.V. All rights reserved.
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