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Step away from the zero lower bound: Small open economies in a world of secular stagnation

Author

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  • Corsetti, G.
  • Mavroeidi, E.
  • Thwaites, G.
  • Wolf, M.

Abstract

We study how small open economies can engineer an escape from deflation and unemployment in a global secular stagnation. Building on the framework of Eggertsson et al. (2016), we show that the transition to full employment requires a dynamic depreciation of the exchange rate, without prejudice for domestic inflation targeting. However, if depreciation has strong income and valuation effects, the escape can be beggar thy self, raising employment but actually lowering welfare. We show that, while a relaxation in the Effective Lower Bound (ELB) can work as a means of raising employment and inflation in financially closed economies, it may have exactly the opposite effect when economies are financially open.

Suggested Citation

  • Corsetti, G. & Mavroeidi, E. & Thwaites, G. & Wolf, M., 2016. "Step away from the zero lower bound: Small open economies in a world of secular stagnation," Cambridge Working Papers in Economics 1645, Faculty of Economics, University of Cambridge.
  • Handle: RePEc:cam:camdae:1645
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    Cited by:

    1. Corsetti, Giancarlo & Kuester, Keith & Müller, Gernot, 2016. "The Case for Flexible Exchange Rates in a Great Recession," CEPR Discussion Papers 11432, C.E.P.R. Discussion Papers.
    2. Giancarlo Corsetti & Keith Kuester & Gernot J. Müller, 2017. "Fixed on Flexible: Rethinking Exchange Rate Regimes after the Great Recession," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 65(3), pages 586-632, August.
    3. Corsetti, Giancarlo & Kuester, Keith & Müller, Gernot J., 2017. "Fixed on flexible rethink exchange rate regimes after the Great Recession," LSE Research Online Documents on Economics 86154, London School of Economics and Political Science, LSE Library.

    More about this item

    Keywords

    Small open economy; secular stagnation; capital controls; optimal policy; zero lower bound;

    JEL classification:

    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy

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