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...

Full description

Bibliographic Details
Main Authors: Hofmann, Boris, Lombardi, Marco Jacopo, Mojon, Benoit, Orphanides, Athanasios
Format: Working Paper
Language:en_US
Published: 2022
Subjects:
Online Access:https://hdl.handle.net/1721.1/141297
_version_ 1811085397799731200
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
work_keys_str_mv AT hofmannboris fiscalandmonetarypolicyinteractionsinalowinterestrateworld
AT lombardimarcojacopo fiscalandmonetarypolicyinteractionsinalowinterestrateworld
AT mojonbenoit fiscalandmonetarypolicyinteractionsinalowinterestrateworld
AT orphanidesathanasios fiscalandmonetarypolicyinteractionsinalowinterestrateworld