TY  - JOUR
AU  - Eggertsson,Gauti B.
AU  - Woodford,Michael
TI  - Optimal Monetary and Fiscal Policy in a Liquidity Trap
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 10840
PY  - 2004
Y2  - October 2004
UR  - http://www.nber.org/papers/w10840
L1  - http://www.nber.org/papers/w10840.pdf
N1  - Author contact info:
Gauti B. Eggertsson
Department of Economics
Brown University
64 Waterman Street
Providence, RI 02912
Tel: 401/863-2145
E-Mail: gauti_eggertsson@brown.edu

Michael Woodford
Department of Economics
Columbia University
420 W. 118th Street
New York, NY 10027
Tel: 212/854-1094
Fax: 212-854-8059
E-Mail: mw2230@columbia.edu
M1  - published as Gauti B. Eggertsson, Michael Woodford. "Optimal Monetary and Fiscal Policy in a Liquidity Trap," in Richard H. Clarida, Jeffrey Frankel, Francesco Giavazzi and Kenneth D. West, editors, "NBER International Seminar on Macroeconomics 2004" The MIT Press (2006)

AB  - In previous work (Eggertsson and Woodford, 2003), we characterized the optimal conduct of monetary policy when a real disturbance causes the natural rate of interest to be temporarily negative, so that the zero lower bound on nominal interest rates binds, and showed that commitment to a history-dependent policy rule can greatly increase welfare relative to the outcome under a purely forward-looking inflation target. Here we consider in addition optimal tax policy in response to such a disturbance, to determine the extent to which fiscal policy can help to mitigate the distortions resulting from the zero bound, and to consider whether a history-dependent monetary policy commitment continues to be important when fiscal policy is appropriately adjusted. We find that even in a model where complete tax smoothing would be optimal as long as the zero bound never binds, it is optimal to temporarily adjust tax rates in response to a binding zero bound; but when taxes have only a supply-side effect, the optimal policy requires that the tax rate be raised during the "trap", while committing to lower tax rates below their long-run level later. An optimal policy commitment is still history-dependent, in general, but the gains from departing from a strict inflation target are modest in the case that fiscal policy responds to the real disturbance in an appropriate way.
ER  -