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Government Spending at the Zero Lower Bound Desirable?

Number: 555
Year: 2015
Author(s): Florin Bilbiie, Tommaso Monacelli, Roberto Perotti
Government spending at the zero lower bound (ZLB) is not necessarily welfare enhancing, even when its output multiplier is large. We illustrate this point in the context of a standard New Keynesian model. In that model, when government spending provides direct utility to the household, its optimal level is at most 0.5- 1 percent of GDP for recessions of -4 percent; the numbers are higher for deeper recessions. When spending does not provide direct utility, it is generically welfare- detrimental: it should be kept unchanged at a long run-optimal value. These results are confirmed in a medium-scale DSGE version of the model featuring sticky wages and equilibrium unemployment.

Keywords: Government spending multiplier, zero lower bound, welfare
JEL codes: E62, D91, E21