MONETARY AND FISCAL POLICY DESIGN AT THE ZERO LOWER BOUND: EVIDENCE FROM THE LAB

Abstract

The global economic crisis of 2007–2008 has pushed many advanced economies into a liquidity trap. We design a laboratory experiment on the effectiveness of policy measures to avoid expectation-driven liquidity traps. Monetary policy alone is not sufficient to avoid liquidity traps, even if it preventively cuts the interest rate when inflation falls below a threshold. However, monetary policy augmented with a fiscal switching rule succeeds in escaping liquidity trap episodes. We measure the effect of fiscal policy on expectations, and report larger-than-unity fiscal multipliers at the zero lower bound. Experimental results in different treatments are well explained by adaptive learning. (JEL E70, C92, D83, D84, E52, E62).