Fiscal and Monetary Policy Interactions in a Low Interest Rate World
We analyse fiscal and monetary policy interactions when interest rate policy is hampered by the zero lower bound (ZLB) in an environment where expectations are formed with perpetual learning. The ZLB induces a deterioration of economic performance and raises the risk of persistent lowflation that ca...
Main Authors: | , , , |
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Format: | Working Paper |
Language: | en_US |
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2022
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Online Access: | https://hdl.handle.net/1721.1/141297 |
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author | Hofmann, Boris Lombardi, Marco Jacopo Mojon, Benoit Orphanides, Athanasios |
author_facet | Hofmann, Boris Lombardi, Marco Jacopo Mojon, Benoit Orphanides, Athanasios |
author_sort | Hofmann, Boris |
collection | MIT |
description | We analyse fiscal and monetary policy interactions when interest rate policy is hampered by the zero lower bound (ZLB) in an environment where expectations are formed with perpetual learning. The ZLB induces a deterioration of economic performance and raises the risk of persistent lowflation that can disanchor inflation expectations and lead to debt deflation. Systematic use of quantitative easing (QE) can partially substitute for interest rate easing and, if sufficiently aggressive, can maintain average inflation in line with the central bank’s goal. By compressing term premia on longterm interest rates, QE creates fiscal space that facilitates expansionary fiscal policy and reduces debt-deflation risk. The ZLB can be counteracted with less aggressive QE if mildly negative policy rates are feasible, if more countercyclical fiscal policy can be activated, or if the central bank can credibly communicate a clear inflation goal. Timidity in implementing QE and excessively debt-averse fiscal policies are counterproductive. |
first_indexed | 2024-09-23T13:08:57Z |
format | Working Paper |
id | mit-1721.1/141297 |
institution | Massachusetts Institute of Technology |
language | en_US |
last_indexed | 2024-09-23T13:08:57Z |
publishDate | 2022 |
record_format | dspace |
spelling | mit-1721.1/1412972022-03-19T03:19:41Z Fiscal and Monetary Policy Interactions in a Low Interest Rate World Hofmann, Boris Lombardi, Marco Jacopo Mojon, Benoit Orphanides, Athanasios Zero Lower Bound, Fiscal Policy, Debt Deflation, Quantitative Easing, Perpetual Learning We analyse fiscal and monetary policy interactions when interest rate policy is hampered by the zero lower bound (ZLB) in an environment where expectations are formed with perpetual learning. The ZLB induces a deterioration of economic performance and raises the risk of persistent lowflation that can disanchor inflation expectations and lead to debt deflation. Systematic use of quantitative easing (QE) can partially substitute for interest rate easing and, if sufficiently aggressive, can maintain average inflation in line with the central bank’s goal. By compressing term premia on longterm interest rates, QE creates fiscal space that facilitates expansionary fiscal policy and reduces debt-deflation risk. The ZLB can be counteracted with less aggressive QE if mildly negative policy rates are feasible, if more countercyclical fiscal policy can be activated, or if the central bank can credibly communicate a clear inflation goal. Timidity in implementing QE and excessively debt-averse fiscal policies are counterproductive. 2022-03-18T17:41:28Z 2022-03-18T17:41:28Z 2022-03-18 Working Paper https://hdl.handle.net/1721.1/141297 en_US MIT Sloan School of Management Working Paper; Bank for International Settlements Working Papers;No. 954 Attribution-NonCommercial-NoDerivs 3.0 United States http://creativecommons.org/licenses/by-nc-nd/3.0/us/ application/pdf |
spellingShingle | Zero Lower Bound, Fiscal Policy, Debt Deflation, Quantitative Easing, Perpetual Learning Hofmann, Boris Lombardi, Marco Jacopo Mojon, Benoit Orphanides, Athanasios Fiscal and Monetary Policy Interactions in a Low Interest Rate World |
title | Fiscal and Monetary Policy Interactions in a Low Interest Rate World |
title_full | Fiscal and Monetary Policy Interactions in a Low Interest Rate World |
title_fullStr | Fiscal and Monetary Policy Interactions in a Low Interest Rate World |
title_full_unstemmed | Fiscal and Monetary Policy Interactions in a Low Interest Rate World |
title_short | Fiscal and Monetary Policy Interactions in a Low Interest Rate World |
title_sort | fiscal and monetary policy interactions in a low interest rate world |
topic | Zero Lower Bound, Fiscal Policy, Debt Deflation, Quantitative Easing, Perpetual Learning |
url | https://hdl.handle.net/1721.1/141297 |
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