Unconventional Fiscal Policy: Theoretical Perspectives, Empirical Challenges, and Future Directions

Abstract

Unconventional fiscal policy (UFP) has emerged as a policy toolkit for macroeconomic stabilization during an effective lower bound, and higher debt-to-GDP environment. As a lesser-known policy, the mechanism of UFP demands serious attention. Hence, this paper presents a comprehensive literature review on UFP. The main objectives are to: (1) synthesize the existing body of research, (2) outline the theoretical underpinnings, (3) examine the key transmission channels including inflation expectations, income and wealth effects, redistributive channel, and uncertainty channels, (4) identify major challenges, and (5) propose future research directions. Our review highlights that UFP is budget-neutral and the inflation expectation channel is the primary channel through which UFP affects consumption. Further, our review identified key challenges in the empirical assessment of UFP, including the need for accurate measurement, noise in the survey data, heterogeneity in inflation expectations, and marginal propensity to consume, as well as the presence of reverse causality, the choice between intertemporal versus intratemporal substitutions, and the role of past inflation. Finally, our study reveals promising avenues for future research. Given the need for an effective stabilizing tool during liquidity traps and low-inflationary environments, our findings are specifically relevant for both policymakers and academics seeking to stimulate aggregate demand.