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The fiscal multiplier and spillover in a global liquidity trap

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  • Fujiwara, Ippei
  • Ueda, Kozo

Abstract

We consider the fiscal multiplier and spillover—the extent to which one country's government expenditure increases production at home and also in another foreign country, when the two countries are caught simultaneously in a liquidity trap. Using a standard new open economy macroeconomics (NOEM) model, we show that the fiscal multiplier and spillover are contrary to textbook economics. For the country where government expenditure takes place, the fiscal multiplier exceeds one, the currency depreciates, and the terms of trade worsen. The fiscal spillover is negative if the intertemporal elasticity of substitution in consumption is less than one, and positive if it is greater than one. Incomplete stabilization of marginal costs due to the existence of the zero lower bound is critical in understanding the effects of fiscal policy in open economies. These results remain unchanged even if we incorporate incomplete markets or endogenous capital into the model, but local currency pricing yields positive fiscal spillover irrespective of the size of the intertemporal elasticity of substitution.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 37 (2013)
Issue (Month): 7 ()
Pages: 1264-1283

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Handle: RePEc:eee:dyncon:v:37:y:2013:i:7:p:1264-1283

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Keywords: Zero lower bound; Two-country model; Fiscal policy; Beggar-thy-neighbor;

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Citations

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Cited by:
  1. Ippei Fujiwara & Yuki Teranishi, 2009. "Financial Stability in Open Economies," IMES Discussion Paper Series 09-E-09, Institute for Monetary and Economic Studies, Bank of Japan.
  2. Ippei Fujiwara, 2010. "Export shocks and the zero bound trap," Globalization and Monetary Policy Institute Working Paper 63, Federal Reserve Bank of Dallas.
  3. repec:csg:ajrcwp:1306 is not listed on IDEAS
  4. Flotho, Stefanie, 2012. "Monetary and Fiscal Policy in a Monetary Union under the Zero Lower Bound constraint," Annual Conference 2012 (Goettingen): New Approaches and Challenges for the Labor Market of the 21st Century 62028, Verein für Socialpolitik / German Economic Association.
  5. Michael B. Devereux & James Yetman, 2014. "Capital Controls, Global Liquidity Traps, and the International Policy Trilemma," Scandinavian Journal of Economics, Wiley Blackwell, vol. 116(1), pages 158-189, 01.
  6. Rod Tyers & Jenny Corbett, 2012. "Japan's economic slowdown and its global implications: a review of the economic modelling," Asian-Pacific Economic Literature, Asia Pacific School of Economics and Government, The Australian National University, vol. 26(2), pages 1-28, November.
  7. Cook, David & Devereux, Michael B., 2011. "Cooperative fiscal policy at the zero lower bound," Journal of the Japanese and International Economies, Elsevier, vol. 25(4), pages 465-486.
  8. David Cook & Michael B. Devereux, 2013. "Sharing the Burden: Monetary and Fiscal Responses to a World Liquidity Trap," American Economic Journal: Macroeconomics, American Economic Association, vol. 5(3), pages 190-228, July.
  9. Cook, David & Devereux, Michael B., 2011. "Optimal fiscal policy in a world liquidity trap," European Economic Review, Elsevier, vol. 55(4), pages 443-462, May.
  10. Charles T Carlstrom & Timothy S Fuerst & Matthius Paustian, 2012. "Fiscal multipliers under an interest rate peg of deterministic vs. stochastic duration," Working Paper 1235, Federal Reserve Bank of Cleveland.

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