Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/248312 
Year of Publication: 
2021
Series/Report no.: 
Bank of Canada Staff Working Paper No. 2021-51
Publisher: 
Bank of Canada, Ottawa
Abstract: 
This paper reconsiders the degree to which macroeconomic stabilization is possible when the zero lower bound is a relevant constraint on the effectiveness of conventional monetary policy, under an assumption of bounded rationality. In particular, we reconsider the potential role of countercyclical fiscal transfers as a tool of stabilization policy. Because Ricardian equivalence no longer holds when planning horizons are finite (even when relatively long), we find that fiscal transfers can be a powerful tool to reduce the contractionary impact of an increased financial wedge during a crisis and can even make possible complete stabilization of both aggregate output and inflation under certain circumstances, despite the binding lower bound on interest rates. However, the power of such policies depends on the degree of monetary policy accommodation. We also show that a higher level of welfare is generally possible if both monetary and fiscal authorities commit themselves to history-dependent policies in the period after the financial disturbance that causes the lower bound to bind has dissipated.
Subjects: 
Monetary policy
Fiscal policy
Central bank research
Business fluctuations and cycles
JEL: 
E52
E63
E7
Persistent Identifier of the first edition: 
Document Type: 
Working Paper

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