Webex-seminar: Old-Keynesianism in the New Keynesian model

Yield curves on advanced economies' government debt imply that financial markets expect short-term interest rates to remain close to or at the Zero Lower Bound (ZLB) for many years or decades to come. In such a situation, conventional monetary policy can no longer be employed for macroeconomic stabilization. Therefore, I investigate an alternative “old Keynesian” fiscal policy in which government spending endogenously responds to inflation and the output gap, while the nominal interest rate is pegged at the ZLB. I do so within a standard Representative Agent New Keynesian model (RANK), as well as a two-period Overlapping Generations New Keynesian model (OLG-NK). For both model versions, I find that the equilibrium values for inflation and the output gap under a standard Taylor rule regime can be replicated under the “old Keynesian” regime. However, a unique stable countercyclical equilibrium is only feasible within the OLG-NK model. Finally I show that the old Keynesian policy features a “fiscal” divine coincidence under which government spending can simultaneously ensure zero inflation and elimination of the output gap.