This paper studies the dynamic behavior of the general price level when the natural rate of interest declines substantially. Particular attention is paid to two constraints: the non-negativity constraint of nominal interest rates, and the government's intertemporal budget constraint. In a normal...

We characterize monetary and fiscal policy rules to implement optimal responses to a substantial decline in the natural rate of interest, and compare them with policy decisions made by the Japanese central bank and government in 1999—2004. First, we find that the Bank of Japan’s policy...