TY - JOUR
T1 - Fiscal stimulus with imperfect expectations
T2 - Spending vs. tax policy
AU - Bianchi-Vimercati, Riccardo
AU - Eichenbaum, Martin
AU - Guerreiro, Joao
N1 - Publisher Copyright:
© 2024 Elsevier Inc.
PY - 2024/4
Y1 - 2024/4
N2 - This paper addresses the question: how sensitive is the power of fiscal policy at the Zero Lower Bound (ZLB) to the assumption of rational expectations? We do so through the lens of a standard New Keynesian model in which people are dynamic level-k thinkers. Our analysis weakens the case for using government spending to stabilize the economy when the ZLB binds. The less sophisticated people are, the smaller the government-spending multiplier is. Our analysis strengthens the case for using tax policy to stabilize output when the ZLB is binding. The power of tax policy to stabilize the economy during the ZLB period is essentially undiminished when agents do not have rational expectations. Our results are robust to whether or not Ricardian equivalence holds. Finally, we show that the way in which tax policy is communicated is critical to its effectiveness.
AB - This paper addresses the question: how sensitive is the power of fiscal policy at the Zero Lower Bound (ZLB) to the assumption of rational expectations? We do so through the lens of a standard New Keynesian model in which people are dynamic level-k thinkers. Our analysis weakens the case for using government spending to stabilize the economy when the ZLB binds. The less sophisticated people are, the smaller the government-spending multiplier is. Our analysis strengthens the case for using tax policy to stabilize output when the ZLB is binding. The power of tax policy to stabilize the economy during the ZLB period is essentially undiminished when agents do not have rational expectations. Our results are robust to whether or not Ricardian equivalence holds. Finally, we show that the way in which tax policy is communicated is critical to its effectiveness.
KW - Fiscal policy
KW - Imperfect information
KW - Rational expectations
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U2 - 10.1016/j.jet.2024.105814
DO - 10.1016/j.jet.2024.105814
M3 - Article
AN - SCOPUS:85189028514
SN - 0022-0531
VL - 217
JO - Journal of Economic Theory
JF - Journal of Economic Theory
M1 - 105814
ER -