New Keynesian Liquidity Trap and Conventional Fiscal Stance: An Estimated DSGE Model

Abstract

The study investigates the effect of New Keynesian liquidity trap on fiscal stance in the United States, United Kingdom and Japan economies. We developed our DSGE model in the context of an optimal and persistent interactive fiscal policy, which allows us to track the transmission channel through which shocks are distributed among real economic variables. The evidence suggests that zero lower bound mitigates the ability of monetary policy to absorb the effect of exogenous shock on the macroeconomic variables while expansionary fiscal policy was able to absorb the shock persistence transmitted from the nominal interest rate.

Monetary Policy Dynamics in the United States

“…The traditional approach to monetary policy is to use fund rates as a tool to manage irregular uctuations in the economy. During a recession, the reserve bank rate is the most e cient policy instrument to spur a recovery (Shobande & Shodipe, 2019a. However, caution must be exercised to ensure that the rates do not drop below the thresholds (Shobande, 2019a;Shobande & Shodipe, 2019b).…”