Date Added: May 2011
This paper analyzes the effectiveness of fiscal policy at zero nominal interest rates. The author solves a stochastic general equilibrium model with sticky prices assuming that the government cannot commit to future policy. Real government spending increases demand by boosting public consumption. Deficit spending increases demand by generating inflation expectations. The author computes multipliers of government spending that calculate by how much each dollar of spending increases output. Both the deficit and the real spending multipliers can be large, but the multiplier of deficit spending depends critically on monetary and fiscal cooperation: it can be large with cooperation and zero without it.