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Cooperative fiscal policy at the zero lower bound

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  • Cook, David
  • Devereux, Michael B.

Abstract

This paper investigates the use of fiscal policy in response to a large negative aggregate demand shock which may push the global economy into a liquidity trap. Fiscal policy may be an effective tool to respond to a liquidity trap, but its international spillover effects may operate quite differently from its domestic effects. We derive the optimal cooperative fiscal response to a global liquidity trap in a two country world economy. Surprisingly, we find that the optimal fiscal spending response for a partner country to a negative aggregate demand shock in a source country may be negative. If fiscal policy can be chosen under policy commitment, the optimal response involves current fiscal expansion combined with future fiscal contraction, after the liquidity trap has ended.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of the Japanese and International Economies.

Volume (Year): 25 (2011)
Issue (Month): 4 ()
Pages: 465-486

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Handle: RePEc:eee:jjieco:v:25:y:2011:i:4:p:465-486

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Web page: http://www.elsevier.com/locate/inca/622903

Related research

Keywords: Liquidity Trap; Monetary Policy; Fiscal Policy; International spillovers;

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References

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  1. 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, vol. 6(1), pages 103-134, March.
  2. Lars E.O. Svensson, 2003. "Escaping from a Liquidity Trap and Deflation: The Foolproof Way and Others," Journal of Economic Perspectives, American Economic Association, vol. 17(4), pages 145-166, Fall.
  3. Fujiwara, Ippei & Ueda, Kozo, 2013. "The fiscal multiplier and spillover in a global liquidity trap," Journal of Economic Dynamics and Control, Elsevier, vol. 37(7), pages 1264-1283.
  4. Beetsma, Roel & Jensen, Henrik, 2002. "Monetary and fiscal policy interactions in a micro-founded model of a monetary union," Working Paper Series 0166, European Central Bank.
  5. Michael Woodford, 2010. "Simple Analytics of the Government Expenditure Multiplier," Discussion Papers 0910-09, Columbia University, Department of Economics.
  6. Ippei Fujiwara & Tomoyuki Nakajima & Nao Sudo & Yuki Teranishi, 2011. "Global Liquidity Trap," KIER Working Papers 780, Kyoto University, Institute of Economic Research.
  7. 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.
  8. Cogan, John F. & Cwik, Tobias & Taylor, John B. & Wieland, Volker, 2009. "New Keynesian versus old Keynesian government spending multipliers," CEPR Discussion Papers 7236, C.E.P.R. Discussion Papers.
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