Working Paper: NBER ID: w20238
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: policy uncertainty; deflation; Great Recession; zero lower bound; fiscal imbalances
JEL Codes: D83; E31; E52; E63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| policy uncertainty (D89) | absence of deflation (E31) |
| fiscal shocks (E62) | inflation during zero lower bound regime (E31) |
| growing fiscal imbalances (E62) | inflationary pressures during Great Recession (E31) |
| removing policy uncertainty (G18) | predicted deflation (E31) |
| policy uncertainty (D89) | trade-off between recession mitigation and long-run stability (E63) |