The Safety Trap: Coordination of Monetary and Fiscal Policies

Abstract

Is expanding balance sheets in the normal a correct approach? Do balance sheet policies provide a much needed new instrument for central banks? In this paper I argue that not necessarily. I show that assuming that the safety trap is a primary reason for low interest rates, some balance sheet policies do not address the problem. The potential approach of a coordinated response of fiscal and monetary policies can address the issue. Applying a game-theoretic approach, I show that the equilibrium achieved by monetary and fiscal authorities acting independently indeed implies undersupply of safe assets leaving output below its potential level. This brings a new perspective on the coordination of monetary and fiscal policies.