Optimal government spending at the zero lower bound: A non-Ricardian analysis

Abstract

This paper analyzes the implications of distortionary taxation and debt financing for optimal government spending policy in a sticky-price economy where the nominal interest rate is subject to the zero lower bound constraint. Regardless of the type of tax available and the initial debt level, optimal government spending policy in a recession is characterized by an initial increase followed by a reduction below, and an eventual return to, the steady state.The magnitude of variations in the government spending as well as their welfare implications depend importantly on the available tax instrument and the initial debt level.JEL: E32, E52, E61, E62, E63

Spending multipliers with distortionary taxes: Does the level of public debt matter?

“…Our results, although derived in a different environment, are qualitatively and quantitatively consistent with those reported byBilbiie, Monacelli, and Perotti (2018) andNakata (2017).…”

“…In our view, this is due to the fact that the labor income tax follows a systematic feedback rule while this variable is an optimized policy instrument in Nakata (2017). In any case the design of optimal policies is not the main focus of our paper.…”

“…Closest to the above analysis are Bilbiie, Monacelli, and Perotti (2018) and Nakata (2017), who derive Ramsey policies subject to ZLB episodes. Some of our results are in perfect accordance with theirs.…”

Time‐Consistent Management of a Liquidity Trap with Government Debt

“…Some studies assign a trivial role to government debt as a result of Ricardian equivalence by assuming that shifts between debt and tax financing do not entail a trade‐off (see, e.g., Werning 2011, Schmidt 2013, Nakata 2016). Others limit the analysis to short‐term debt, which is typically assumed to mature every quarter (see, e.g., Eggertsson and Woodford 2006, Eggertsson 2006, Burgert and Schmidt 2014, Nakata 2017a). In practice, however, tax financing is associated with distortions, and the average maturity of government debt across G‐7 countries varies from 4 to 14 years (Greenwood et al.…”

The Government Spending Multiplier in a (Mis)Managed Liquidity Trap

“…There is a large literature investigating how government spending should be set optimally over the cycle, see, for instance, Werning (), Woodford (), Nakata (), Schmidt (), Bilbiie, Monacelli, and Perotti (), and Nakata (). In related work, Bouakez, Guillard, and Roulleau‐Pasdeloup () develop a more general setup in which both public consumption and investment can be set optimally over the cycle.…”