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Is There A Fiscal Free Lunch In A Liquidity Trap?

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Executive Summary

This paper uses a DSGE model to examine the effects of an expansion in government spending in a liquidity trap. If the liquidity trap is very prolonged, the spending multiplier can be much larger than in normal circumstances, and the budgetary costs minimal. But given this "Fiscal free lunch," it is unclear why policymakers would want to limit the size of fiscal expansion. The authors' paper addresses this question in a model environment in which the duration of the liquidity trap is determined endogenously, and depends on the size of the fiscal stimulus.

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