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Good (and not so good) policy at the zero bound
The fact that nominal interest rates cannot be negative implies that when nominal interest rates cannot be further reduced, alternative policies must be considered to provide stimulus, should it be needed. This note is an assessment of fiscal policies at the zero bound. Using a model for the euro area, we illustrate and quantify the effects of fiscal policy responses to a major recession that leads the economy to the zero lower bound on interest rates. First, we show that ad-hoc fiscal policy measures lead to results that are very different from the efficient allocation. Then, drawing on the results in Correia, Farhi, Nicolini and Teles (2011), we show how fiscal policy should be designed to replicate the efficient allocation.