I have been investigating the role of super-active fiscal policies, policies that increase government spending or cut taxes as debt levels rise in joint work with Roberto Billi. We find that such polices can outperform standard inflation targeting when monetary policy is occasionally constrained by the zero lower bound. Our most recent version of Seemingly irresponsible but welfare improving fiscal policy at the lower bound extends the analysis to consider deviations from rational expectations in the form of cognitive discounting.
Using a standard New Keynesian model subject to an occasionally-binding zero lower bound on the monetary policy interest rate and a model-consistent measure of welfare, we show that such seemingly irresponsible fiscal rules can improve economic welfare. While sensible fiscal policy and active monetary policy performs best away from the ZLB, the fiscal rules we analyze significantly reduce the time spent at the ZLB and produce overall welfare gains.
Super-active fiscal policies are most effective with a high debt target and when debt is short-term. However, when private expectations are characterized by cognitive discounting, the performance of super-active fiscal rules deteriorates.
Roberto and I wrote a SUERF policy brief in April 2022 was summarized our results from an earlier version of this paper that did not consider deviations from rational expectation.
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