Interaction of fiscal and monetary policy in a monetary union under the zero lower bound constraint

Abstract

This paper analyses the interaction of monetary and fiscal policies in a dynamic stochastic general equilibrium model of a monetary union where conventional monetary policy is restricted by the binding zero lower bound constraint. We use the OccBin toolkit to analyze the performance of optimally set monetary and fiscal policies and compare outcomes with simple rules for government spending or the interest rate. Government spending are set independently from each other. We make several findings. First, fiscal policy plays an active role in stabilizing the economy under the binding zero lower bound constraint. Second, properly designed fiscal policy can even shorten the duration of the binding constraint. Third, coordination of policies is not always preferable.