Fiscal policy under secular stagnation: An optimal pump-priming strategy

Abstract

How can a depressed economy escape a permanent liquidity trap, such as to restore full employment? This can be achieved through a temporary, but massive, fiscal stimulus to overheat the economy such as to raise the inflation anchor. Despite the substantial cost of overheating the economy, this pump-priming policy is typically optimal. The lack of fiscal space cannot prevent the government from pump priming the economy through fiscal policy.