Optimal government spending at the zero lower bound for a small open economy

Available from: 
October 2013
Paper author(s): 
Gustavo González (Pontificia Universidad Católica de Chile)
Macroeconomics - Economic growth - Monetary Policy

During Great Recession central banks of developed countries pulled down their nominal interest rates to levels very close to zero. This brought to the scene the problem of the zero lower bound and the circumstantial ineffectiveness of monetary policy to stabilize the economy. This motivated vast research about the role of fiscal policy as a substitute stabilization tool. However, few investigations have approached this theme from the perspective of a small open economy. This paper studies the optimal government spending at a binding zero lower bound for a small open economy using a traditional neo-Keynesian model under a flexible and a fixed exchange rate regime. I find that, as much of the literature in closed economy, even if Ricardian Equivalence holds, government spending can have considerable effects over output gap and prices, improving welfare over the state with no government interference, being this more acute in the case of a flexible exchange rate regime.


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Research section: 
Lacea 2013 annual meeting
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