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Sharing the Burden: Monetary and Fiscal Responses to a World Liquidity Trap

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  • David Cook
  • Michael B. Devereux

Abstract

This paper analyzes optimal policy responses to a global liquidity trap. The key feature of this environment is that relative prices respond perversely. A fall in demand in one country causes an appreciation of its terms of trade, exacerbating the initial shock. At the zero bound, this country cannot counter this shock. Then it may be optimal for the partner country to raise interest rates. The partner may set a positive policy interest rate, even though its “natural interest rate†is below zero. An optimal policy response requires a mutual interaction between monetary and fiscal policy.

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Bibliographic Info

Article provided by American Economic Association in its journal American Economic Journal: Macroeconomics.

Volume (Year): 5 (2013)
Issue (Month): 3 (July)
Pages: 190-228

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Handle: RePEc:aea:aejmac:v:5:y:2013:i:3:p:190-228

Note: DOI: 10.1257/mac.5.3.190
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References

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  1. Michael Woodford, 2010. "Simple Analytics of the Government Expenditure Multiplier," NBER Working Papers 15714, National Bureau of Economic Research, Inc.
  2. John Cogan & Tobias Cwik & John Taylor & Volker Wieland, 2009. "New Keynesian Versus Old Keynesian Government Spending Multipliers," Discussion Papers, Stanford Institute for Economic Policy Research 08-030, Stanford Institute for Economic Policy Research.
  3. Faia, Ester & Monacelli, Tommaso, 2006. "Optimal Monetary Policy in a Small Open Economy with Home Bias," CEPR Discussion Papers, C.E.P.R. Discussion Papers 5522, C.E.P.R. Discussion Papers.
  4. Lars E.O. Svensson, 2003. "Escaping from a Liquidity Trap and Deflation: The Foolproof Way and Others," NBER Working Papers 10195, National Bureau of Economic Research, Inc.
  5. Martin Bodenstein & Christopher J. Erceg & Luca Guerrieri, 2009. "The effects of foreign shocks when interest rates are at zero," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 983, Board of Governors of the Federal Reserve System (U.S.).
  6. Julio J. Rotemberg & Michael Woodford, 1998. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy: Expanded Version," NBER Technical Working Papers 0233, National Bureau of Economic Research, Inc.
  7. Beetsma, Roel & Jensen, Henrik, 2002. "Monetary and fiscal policy interactions in a micro-founded model of a monetary union," Working Paper Series, European Central Bank 0166, European Central Bank.
  8. Jess Benhabib & Stephanie Schmitt-Grohe & Martin Uribe, 2000. "Avoiding Liquidity Traps," Departmental Working Papers, Rutgers University, Department of Economics 199925, Rutgers University, Department of Economics.
  9. Lawrence J. Christiano & Martin Eichenbaum & Sergio Rebelo, 2010. "When is the government spending multiplier large?," CQER Working Paper, Federal Reserve Bank of Atlanta 2010-01, Federal Reserve Bank of Atlanta.
  10. Troy Davig & Eric M. Leeper, 2009. "Monetary-Fiscal Policy Interactions and Fiscal Stimulus," NBER Working Papers 15133, National Bureau of Economic Research, Inc.
  11. Fujiwara, Ippei & Ueda, Kozo, 2013. "The fiscal multiplier and spillover in a global liquidity trap," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 37(7), pages 1264-1283.
  12. Roberto Perotti, 2008. "In Search of the Transmission Mechanism of Fiscal Policy," NBER Chapters, in: NBER Macroeconomics Annual 2007, Volume 22, pages 169-226 National Bureau of Economic Research, Inc.
  13. Benigno, Gianluca & Benigno, Pierpaolo, 2006. "Designing targeting rules for international monetary policy cooperation," Journal of Monetary Economics, Elsevier, Elsevier, vol. 53(3), pages 473-506, April.
  14. Ippei Fujiwara & Tomoyuki Nakajima & Nao Sudo & Yuki Teranishi, 2011. "Global Liquidity Trap," KIER Working Papers, Kyoto University, Institute of Economic Research 780, Kyoto University, Institute of Economic Research.
  15. Olivier Blanchard & Roberto Perotti, 2002. "An Empirical Characterization Of The Dynamic Effects Of Changes In Government Spending And Taxes On Output," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 117(4), pages 1329-1368, November.
  16. Cook, David & Devereux, Michael B., 2011. "Optimal fiscal policy in a world liquidity trap," European Economic Review, Elsevier, Elsevier, vol. 55(4), pages 443-462, May.
  17. Tommaso Monacelli & Roberto Perotti, 2008. "Fiscal Policy, Wealth Effects, and Markups," NBER Working Papers 14584, National Bureau of Economic Research, Inc.
  18. Ippei Fujiwara & Nao Sudo & Yuki Teranishi, 2010. "The Zero Lower Bound and Monetary Policy in a Global Economy: A Simple Analytical Investigation," International Journal of Central Banking, International Journal of Central Banking, International Journal of Central Banking, vol. 6(1), pages 103-134, March.
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Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. Monetary and fiscal policy cooperation in a liquidity trap
    by Economic Logician in Economic Logic on 2011-10-03 14:39:00
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Cited by:
  1. Benigno, Pierpaolo & Romei, Federica, 2012. "Debt Deleveraging and the Exchange Rate," CEPR Discussion Papers, C.E.P.R. Discussion Papers 8938, C.E.P.R. Discussion Papers.
  2. Michael B. Devereux & James Yetman, 2014. "Globalisation, Pass-through and the Optimal Policy Response to Exchange Rates," NBER Working Papers 20252, National Bureau of Economic Research, Inc.
  3. Schmidt, Sebastian, 2014. "Fiscal activism and the zero nominal interest rate bound," Working Paper Series, European Central Bank 1653, European Central Bank.
  4. Luca Fornaro, 2012. "International debt deleveraging," Economics Working Papers, Department of Economics and Business, Universitat Pompeu Fabra 1401, Department of Economics and Business, Universitat Pompeu Fabra, revised Nov 2013.
  5. Matthieu Bussière & Jean Imbs & Robert Kollmann & Romain Rancière, 2013. "The Financial Crisis: Lessons for International Macroeconomics," American Economic Journal: Macroeconomics, American Economic Association, American Economic Association, vol. 5(3), pages 75-84, July.

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  1. Sharing the Burden: Monetary and Fiscal Responses to a World Liquidity Trap (AEJ:MA 2013) in ReplicationWiki
  2. Economic Logic blog

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