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The effects of foreign shocks when interest rates are at zero

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  • Martin Bodenstein
  • Christopher J. Erceg
  • Luca Guerrieri

Abstract

In a two‐country DSGE model, the effects of foreign demand shocks on the home country are greatly amplified if the home economy is constrained by the zero lower bound on policy interest rates. This result applies even to countries that are relatively closed to trade such as the United States. Departing from many of the existing closed‐economy models, the duration of the liquidity trap is determined endogenously. Adverse foreign shocks can extend the duration of the trap, implying more contractionary effects for the home country. The home economy is more vulnerable to adverse foreign shocks if the neutral rate is low—consistent with “secular stagnation”—and trade openness is high. Les effets de chocs en provenance de l’étranger quand les taux d’intérêt sont à zéro. Dans un modèle d’équilibre général dynamique stochastique, les effets de chocs dans la demande étrangère sur l’économie domestique sont grandement amplifiés si l’économie domestique est limitée dans la définition de sa politique de taux d’intérêt par la borne inférieure zéro. Voilà qui s’applique même pour les pays relativement moins ouvert au commerce international comme les Ètats‐Unis. Prenant ses distances de plusieurs des modèles existants d’économie fermée, la durée de la période de trappe à liquidité où la politique monétaire est inefficace est déterminée de façon endogène. Des chocs externes négatifs peuvent accroître cette période, avec pour conséquence de plus grands effets de contraction pour l’économie domestique. L’économie domestique est plus vulnérable aux chocs négatifs de l’étranger si le taux d’intérêt neutre à long terme compatible avec le plein emploi est bas – consistent avec la stagnation séculaire – et l’ouverture au commerce grande.

Suggested Citation

  • Martin Bodenstein & Christopher J. Erceg & Luca Guerrieri, 2017. "The effects of foreign shocks when interest rates are at zero," Canadian Journal of Economics/Revue canadienne d'économique, John Wiley & Sons, vol. 50(3), pages 660-684, August.
  • Handle: RePEc:wly:canjec:v:50:y:2017:i:3:p:660-684
    DOI: 10.1111/caje.12274
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    More about this item

    JEL classification:

    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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