Optimal robust monetary and fiscal policy under uncertainty on the lower bound
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Date
2024
Authors
Akbal, Gülserim Özcan
Traficante, Guido
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Elsevier
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Abstract
This paper studies robust policy when the policymaker has Knightian uncertainty about the exact position of the effective lower bound (ELB). First, we characterize optimal discretionary policy when a benevolent policymaker controls the nominal interest rate and the level of government spending. Compared to the full information case, an uncertainty -averse policymaker overestimates the level of the ELB, thereby triggering a more aggressive reduction in the nominal interest rate prior to the liquidity trap. Furthermore, the anticipation of a larger increase in public spending improves the trade-off between inflation and the output gap, and dampens the perceived worst -case level of the ELB. As a result, a less conservative fiscal stabilization is desirable to address the uncertainty concerns of the policymaker by partially substituting for the nominal interest rate at the ELB. Moreover, an inflation -conservative policymaker mitigates the impact of uncertainty on equilibrium outcomes even better than a fiscally active policymaker.
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Keywords
Monetary policy, Fiscal policy, Discretion, Liquidity trap, Robust control, Knightian uncertainty
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0
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Q3
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Volume
81