Fiscal Stimulus of Last Resort

I examine global dynamics in a monetary model with overlapping generations of finite-horizon agents, nonseparable preferences over consumption and real money balances, and a binding lower bound on nominal interest rates. Debt targeting rules exacerbate the possibility of self-fulfilling liquidity traps, for agents expect austerity following deflationary slumps. Conversely, activist but sustainable fiscal policy regimes-implementing intertemporally balanced tax cuts and/or transfer increases in response to disinflationary trajectories-are capable of escaping liquidity traps and embarking inflation into a globally stable path that converges to the target. Should fiscal stimulus of last resort be overly aggressive, however, spiral dynamics around the liquidity-trap steady state exist, causing global indeterminacy.