Optimal government spending at the zero lower bound: A non-Ricardian analysis

Abstract

This paper analyzes the implications of distortionary taxation and debt financing for optimal government spending policy in a sticky-price economy in which the nominal interest rate is subject to the zero lower bound constraint. Regardless of the type of tax available and the initial debt level, optimal government spending policy in a recession is characterized by an initial increase followed by a reduction below, and an eventual return to, the steady state. The magnitude of variations in government spending as well as their welfare implications depend importantly on the available tax instrument and the initial debt level.