DP8642 Supply-Side Policies and the Zero Lower Bound

Author(s): Jesús Fernández-Villaverde, Pablo A. Guerron-Quintana, Juan Francisco Rubio-Ramírez
Publication Date: November 2011
Keyword(s): New Keynesian models, supply-side policies, zero lower bound
JEL(s): E30, E50, E60
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=8642

This paper examines how supply-side policies may play a role in fighting a low aggregate demand that traps an economy at the zero lower bound (ZLB) of nominal interest rates. Future increases in productivity or reductions in mark-ups triggered by supply-side policies generate a wealth effect that pulls current consumption and output up. Since the economy is at the ZLB, increases in the interest rates do not undo this wealth effect, as we will have in the case outside the ZLB. We illustrate this mechanism with a simple two-period New Keynesian model. We discuss possible objections to this set of policies and the relation of supply-side policies with more conventional monetary and fiscal policies.