Achieving two policy targets with one policy instrument: heterogeneous expectations, countercyclical fiscal policy, and macroeconomic stabilization at the effective lower bound

Gilberto Lima, Mark Setterfield and Jaylson Silveira ()

No 2301, Working Papers from New School for Social Research, Department of Economics

Abstract: We explore the short-term macrodynamics of stabilization policy at the effective lower bound (ELB) of the nominal interest rate, in an environment characterized by heterogenous and endogenously time-varying private-sector output and inflation expectations driven by evolutionary dynamics. We show that at the ELB, fiscal policy conducted in accordance with a well-specified policy rule is particularly effective for purposes of macroeconomic stabilization. This is because fiscal interventions have both a direct effect on output and inflation (via aggregate demand formation) and an indirect effect on these same target variables, via the management of heterogenous and evolving expectations. As a result of the two channels through which it operates, and seemingly despite the logic of the Tinbergen (targets-instruments) principle, fiscal policy is thus revealed as a single policy instrument capable of achieving two policy goals.

Keywords: Stabilization policy; effective lower bound; fiscal policy; heterogeneous inflation and output expectations; satisficing evolutionary dynamics (search for similar items in EconPapers)
JEL-codes: E12 E52 E62 E63 E71 (search for similar items in EconPapers)
Pages: 28 pages
Date: 2023-01
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http://www.economicpolicyresearch.org/econ/2023/NSSR_WP_012023.pdf First version, 2023 (application/pdf)

Related works:
Working Paper: Achieving two policy targets with one policy instrument: heterogeneous expectations, countercyclical fiscal policy, and macroeconomic stabilization at the effective lower bound (2023)
Working Paper: Achieving two policy targets with one policy instrument: heterogeneous expectations, countercyclical fiscal policy, and macroeconomic stabilization at the effective lower bound (2023)
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