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Fiscal Policy at the Zero Lower Bound Without Rational Expectations

2021; RELX Group (Netherlands); Linguagem: Inglês

10.2139/ssrn.3901599

1556-5068

Riccardo Bianchi-Vimercati, Martin Eichenbaum, João Guerreiro,

Monetary Policy and Economic Impact

We address the question of how sensitive is the power of fiscal policy in the ZLB to the assumption of rational expectations. We do so through the lens of a standard NK model in which people are level-k thinkers. Our analysis weakens the case for using government spending to stabilize the economy when the ZLB binds. The less sophis- ticated people are, the smaller is the size of the government-spending multiplier. Our analysis strengthens the case for using tax policy to stabilize output when the ZLB is binding. The power of tax policy to stabilize the economy during the ZLB period is essentially undiminished when agents do not have rational expectations. Finally, we show that the way in which tax policy is communicated is critical to its effectiveness.Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.