Fiscal Multipliers Under the Effective Lower Bound: Evidence from Japan with Censored Interest Rate Model

Abstract

This paper examines whether fiscal multipliers are affected when nominal interest rates are constrained by the effective lower bound (ELB). Using Japan’s prolonged experience under the ELB, we estimate a time-varying parameter VAR model with Tobit-type nonlinearity in the short-term interest rate. The estimates are suggestive of somewhat larger multipliers under the ELB-binding case, particularly at longer horizons, but the differences are modest. To the extent that any difference is present, it is consistent with an interest-rate channel in which monetary policy is constrained from responding fully to inflationary pressures, permitting a larger decline in real interest rates. These qualitative patterns are robust to controlling for fiscal foresight and to using the GDP gap as an alternative output measure.