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The Fiscal Multiplier and Spillover in a Global Liquidity Trap

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  • Ippei Fujiwara

    (Director, Financial Markets Department, Bank of Japan (E-mail: ippei.fujiwara boj.or.jp))

  • Kozo Ueda

    (Director, Institute for Monetary and Economic Studies, Bank of Japan (E-mail: kouzou.ueda boj.or.jp))

Abstract

We consider the fiscal multiplier and spillover in an environment in which two countries are caught simultaneously in a liquidity trap. Using an optimizing two-country sticky price model, we show that the fiscal multiplier and spillover are contrary to those predicted in textbook economics. For the country with government expenditure, 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 the parameter is greater than one. Incomplete stabilization of marginal costs due to the existence of the zero lower bound is a crucial factor in understanding the effects of fiscal policy in open economies.

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Bibliographic Info

Paper provided by Institute for Monetary and Economic Studies, Bank of Japan in its series IMES Discussion Paper Series with number 10-E-03.

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Date of creation: Mar 2010
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Handle: RePEc:ime:imedps:10-e-03

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Keywords: Zero lower bound; two-country model; fiscal policy; beggar-thy-neighbor;

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Cited by:
  1. 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.
  2. David Cook & Michael B. Devereux, 2011. "Sharing the burden: monetary and fiscal responses to a world liquidity trap," Globalization and Monetary Policy Institute Working Paper 84, Federal Reserve Bank of Dallas.
  3. 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.
  4. 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.
  5. Michael B. Devereux & James Yetman, 2013. "Capital Controls, Global Liquidity Traps and the International Policy Trilemma," NBER Working Papers 19091, National Bureau of Economic Research, Inc.
  6. Charles T. Carlstrom & Timothy S. Fuerst & Matthius Paustian, 2012. "Fiscal multipliers under an interest rate peg of deterministic vs. stochastic duration," Working Paper 1215, Federal Reserve Bank of Cleveland.
  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. 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.
  9. Ippei Fujiwara, 2010. "Export shocks and the zero bound trap," Globalization and Monetary Policy Institute Working Paper 63, Federal Reserve Bank of Dallas.
  10. Ippei Fujiwara, Yuki Teranishi, 2013. "Financial stability in open economies," AJRC Working Papers 1306, Australia-Japan Research Centre, Crawford School of Public Policy, The Australian National University.

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