Working Paper: CEPR ID: DP9643
Authors: Francesco Bianchi; Leonardo Melosi
Abstract: We show that policy uncertainty about how the rising public debt will be stabilized accounts for the lack of deflation in the US economy at the zero lower bound. We first estimate a Markov-switching VAR to highlight that a zero-lower-bound regime captures most of the comovements during the Great Recession: a deep recession, no deflation, and large fiscal imbalances. We then show that a micro-founded model that features policy uncertainty accounts for these stylized facts. Finally, we highlight that policy uncertainty arises at the zero lower bound because of a trade-off between mitigating the recession and preserving long-run macroeconomic stability
Keywords: Bayesian methods; Markov-switching models; Monetary and fiscal policy interaction; Policy uncertainty; Shock-specific policy rules; Zero lower bound
JEL Codes: D83; E31; E52; E62; E63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| large contraction in real activity (E44) | switch to ZLB regime (E63) |
| fiscal shocks (E62) | inflation during ZLB (E31) |
| policy uncertainty regarding fiscal stabilization (E63) | lack of deflation (E31) |
| removing policy uncertainty (G18) | significant deflation (E31) |
| switch to ZLB regime (E63) | tradeoff between stimulating economy and adhering to fiscal discipline (E62) |
| high public debt levels (H69) | inflationary pressures (E31) |