Liquidity Traps in a World Economy

Kollmann, Robert (2021): Liquidity Traps in a World Economy.

Abstract

This paper studies a New Keynesian model of a two-country world with a zero lower bound (ZLB) constraint for nominal interest rates. A floating exchange rate regime is assumed. The presence of the ZLB generates multiple equilibria. The two countries can experience recurrent liquidity traps induced by the self-fulfilling expectation that future inflation will be low. These “expectations-driven” liquidity traps can be synchronized or unsynchronized across countries. In an expectations-driven liquidity trap, the domestic and international transmission of persistent shocks to productivity and government purchases differs markedly from shock transmission in a “fundamentals-driven” liquidity trap.

• Item Type: MPRA Paper
• Language: English
• Keywords: Zero lower bound, expectations-driven and fundamentals-driven liquidity traps, domestic and international shock transmission, terms of trade, exchange rate, net exports
• Subjects: E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles; E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates; F - International Economics > F2 - International Factor Movements and International Business; F - International Economics > F3 - International Finance; F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance

References

Acharya, Sushant and Julien Bengui, 2018. Liquidity Traps, Capital Flows. Journal of International Economics 114, 276-298.

Alvarez, Luis, Emmanuel Dhyne, Marco Hoeberichts, Claudia Kwapil, Hervé Le Bihan, Patrick Lünnemann, Fernando Martins, Roberto Sabbatini, Harald Stahl, PhilipVermeulen and Jouko Vilmunen, 2006. Journal of the European Economic Association 4, 575-584.

Andrade, Philippe, Jordi Galí, Hervé Le Bihan and Julien Matheron, 2019. The Optimal Inflation Target and the Natural Rate of Interest. Brookings Papers on Economic Activity, Fall 2019, 173-230.

Andrade, Philippe, Jordi Galí, Hervé Le Bihan and Julien Matheron, 2020. Should the ECB Adjust its Strategy in the Face of a Lower Natural Rate of Interest? Working Paper

Arifovic, Jasmina, Stephanie Schmitt-Grohé and Martin Uribe, 2018. Learning to Live in a Liquidity Trap. Journal of Economic Dynamics & Control 89, 120-136.

Aruoba, Boragan, Pablo Cuba-Borda and Frank Schorfheide, 2018. Macroeconomic Dynamics Near the ZLB: a Tale of Two Countries. Review of Economic Studies 85, 87-118.

Backus, David, Patrick Kehoe, and Finn Kydland, 1994. Dynamics of the Trade Balance and the Terms of Trade: The J-Curve? American Economic Review 84, 84-103.

Backus, David, and Gregor Smith, 1993. Consumption and Real Exchange Rates in Dynamic Economies with Non-traded Goods. Journal of International Economics 35, 297-316.

Badarau, Cristina and Ibrahima Sangaré, 2019. Exchange Rate Regimes in a Liquidity Trap. Journal of International Money and Finance 93, 55-80.

Balfoussia, Hiona, Harris Dellas, Dimitris Papageorgiou and Evangelia Vourvachaki, 2020. How Does the ZLB Affect the Properties of Alternative Exchange Rate Systems? Working Paper, Bank of Greece.

Benhabib, Jess, Stephanie Schmitt-Grohé and Martín Uribe, 2001a. The Perils of Taylor Rules. Journal of Economic Theory 96, 40-69.

Benhabib, Jess, Stephanie Schmitt-Grohé and Martín Uribe, 2001b. Monetary Policy and Multiple Equilibria. American Economic Review 91, 167-186.

Benhabib, Jess, Stephanie Schmitt-Grohé and Martín Uribe, 2002a. Avoiding Liquidity Traps. Journal of Political Economy 110, 535-563

Benhabib, Jess, Stephanie Schmitt-Grohé and Martín Uribe, 2002b. Chaotic Interest-Rate Rules. American Economic Review 92, 72-78.

Benigno, Gianluca and Luca Fornaro, 2018. Stagnation Traps. Review of Economic Studies 85, 1425-1470.

Blanchard, Olivier, Christopher Erceg and Jesper Lindé, 2016. Jump-Starting the Euro Area Recovery: Would a Rise in Core Fiscal Spending Help the Periphery? NBER Macroeconomics Annual 31, 103-182.

Bussière, Matthieu, Giovanni Callegari, Fabio Ghironi, Giulia Sestieri, Norihiko Yamano, 2013. Estimating Trade Elasticities: Demand Composition and the Trade Collapse of 2008-2009. American Economic Journal: Macroeconomics 5, 118-151.

Calvo, Guillermo, 1983. Staggered Prices in a Utility-Maximizing Framework. Journal of Monetary Economics 12, 383-398.

Christiano, Larry, Martin Eichenbaum and Sergio Rebelo, 2011. When is the Government Spending Multiplier Large? Journal of Political Economy 119, 78-121.

Cochrane, John, 2017. The New Keynesian Liquidity Trap. Journal of Monetary Economics 92, 47-63.

Coenen, Günter, Carlos Montes-Galdon and Sebastian Schmidt, 2020. Macroeconomic Stabilisation and Monetary Policy Effectiveness in a Low-Interest-Rate Environment. Working Paper, ECB.

Cole, Harold and Maurice Obstfeld, 1991. Commodity Trade and International Risk Sharing. Journal of Monetary Economics 28, 3-24.

Cook, David and Michael Devereux, 2013. Sharing the Burden: Monetary and Fiscal responses to a World Liquidity Trap 5, 190-228.

Cook, David and Michael Devereux, 2016. Exchange Rate Flexibility Under the Zero Lower Bound. Journal of International Economics 101, 52–69.

Corsetti, Giancarlo, Eleonora Mavroeidi, Gregory Thwaites and Martin Wolf, 2018. Step Away from the Zero Lower Bound: Small Open Economies in a World of Secular Stagnation. Journal of International Economics 116, 88-102.

Eggertsson, Gauti and Michael Woodford, 2003. The Zero Bound on Interest Rates and Optimal Monetary Policy. Brookings Papers on Economic Activity 1:2003, 139-211.

Eggertsson, Gauti, 2010. The Paradox of Toil. Staff Report 433, Federal Reserve Bank of New York.

Eggertsson, Gauti and Paul Krugman, 2012. Debt, Deleveraging, and the Liquidity Trap: A Fisher-Minsky-Koo Approach. Quarterly Journal of Economics 127, 1469-1513.

Erceg, Christopher and Jesper Lindé, 2010. Asymmetric Shocks in a Currency Union with Monetary and Fiscal Handcuffs. NBER International Seminar on Macroeconomics 7, 95-136.

Erceg, Christopher, Zoltan Jakab and Jesper Lindé, 2020. Monetary Policy Strategies for the European Central Bank. Working Paper, IMF.

Farhi, Emmanuel and Ivan Werning, 2016. Fiscal Multipliers: Liquidity Traps and Currency Unions. In: Handbook of Macroeconomics (J. Taylor and H. Uhlig, eds.), Elsevier, Vol. 2B, 2417-2492.

Farhi, Emmanuel, Ricardo Caballero and Pierre-Olivier Gourinchas, 2020. Global Imbalances and Policy Wars at the Zero Lower Bound. CEPR Discussion Paper 14424.

Fornaro, Luca and Federica Romei, 2019. The Paradox of Global Thrift. American Economic Review 109, 3745-3779.

Fujiwara, Ippei and Kozo Ueda, 2013. The Fiscal Multiplier and Spillover in a Global Liquidity Trap. Journal of Economic Dynamics & Control 37, 1264-1283.

Gomez, Sandra, Pascal Jacquinot, Ricardo Mestre and Joao Sousa. 2015. Global Policy at the Zero Lower Bound in a Large-Scale DSGE Model. Journal of International Money and Finance 50, 134-153.

Giovannini, Massimo, Stefan Hohberger, Robert Kollmann, Marco Ratto, Werner Roeger and Lukas Vogel, 2019. Euro Area and U.S. External Adjustment: The Role of Commodity Prices and Emerging Market Shocks. Journal of International Money and Finance 94, 183-205.

Hicks, John, 1937. Mr. Keynes and the “Classics”: A Suggested Interpretation. Econometrica 5, 147-159. Holden, Tom, 2016. Computation of Solutions to Dynamic Models With Occasionally Binding Constraints. Working Paper.

Holden, Tom, 2019. Existence and Uniqueness of Solutions to Dynamic Models With Occasionally Binding Constraints. Working Paper, Deutsche Bundesbank.

Jeanne, Olivier, 2009. Global Liquidity Traps, Working Paper.

Jeanne, Olivier, 2010. La Trappe à Liquidité Globale. Revue Economique 61, 395-406.

Keynes, John Maynard, 1936. The General Theory of Employment, Interest and Money. London: Macmillan.

King, Robert and Sergio Rebelo, 1999. Resuscitating Real Business Cycles, in: Handbook of Macroeconomics (J. Taylor and M. Woodford, eds.), Elsevier, Vol. 1B, pp. 927-1007.

Kollmann, Robert, 1991. Essays on International Business Cycles. PhD Dissertation, Economics Department, University of Chicago.

Kollmann, Robert, 1995. Consumption, Real Exchange Rates and the Structure of International Asset Markets. Journal of International Money and Finance 14, 191-211.

Kollmann, Robert, 2001. The Exchange Rate in a Dynamic-Optimizing Business Cycle Model with Nominal Rigidities: a Quantitative Investigation. Journal of International Economics 55, 243-262.

Kollmann, Robert, 2002. Monetary Policy Rules in the Open Economy: Effects on Welfare and Business Cycles. Journal of Monetary Economics 49, 989-1015.

Kollmann, Robert, 2004. Welfare Effects of a Monetary Union. Journal of the European Economic Association 2, 289-301.

Kollmann, Robert, Marco Ratto, Werner Roeger, Jan in’t Veld and Lukas Vogel, 2015. What Drives the German Current Account? And How Does it Affect Other EU Member States? Economic Policy 40, 47-93.

Kollmann, Robert, 2020. Liquidity Traps in a Monetary Union. CEPR Discussion Paper 15148.

Krugman, Paul, 1998. It’s Baaack: Japan’s Slump and the Return of the Liquidity Trap. Brookings Papers on Economic Activity 2:1998, 137-205.

Lubik, Thomas and Frank Schorfheide, 2003. Computing Sunspot Equilibria in Linear Rational Expectations Models. Journal of Economic Dynamics & Control 28, 273-285.

Lubik, Thomas and Frank Schorfheide, 2004. Testing for Indeterminacy: An Application to U.S. Monetary Policy. American Economic Review 94, 190-217.

Maliar, Lilia and John Taylor, 2019. Forward Guidance: Is It Useful Away From the Lower Bound?. NBER Working Paper 26053.

Mertens, Karel and Morten Ravn, 2014. Fiscal Policy in an Expectations-Driven Liquidity Trap. Review of Economic Studies 81, 1637-1667.

Nakata, Taisuke and Sebastian Schmidt, 2020. Expectations-Driven Liquidity Traps: Implications for Monetary and Fiscal Policy. CEPR Discussion Paper 15422.

Roeger, Werner, 2015. The Fiscal Multiplier and the Duration of the ZLB Constraint. Working Paper, European Commission.