Finance and Economics Discussion Series (FEDS)
June 2015
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.
Keywords: Commitment, distortionary taxation, government spending, liquidity trap, nominal debt, optimal policy, zero lower bound
DOI: http://dx.doi.org/10.17016/FEDS.2015.038
PDF: Full Paper