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Global Imbalances and Currency Wars at the ZLB

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  • Caballero, Ricardo
  • Farhi, Emmanuel
  • Gourinchas, Pierre-Olivier

Abstract

This paper explores the consequences of extremely low equilibrium real interest rates in a world with integrated but heterogenous capital markets, and nominal rigidities. In this context, we establish five main results: (i) Economies experiencing liquidity traps pull others into a similar situation by running current account surpluses; (ii) Reserve currencies have a tendency to bear a disproportionate share of the global liquidity trap—a phenomenon we dub the "reserve currency paradox;" (iii) Beggar-thy-neighbor exchange rate devaluations stimulate the domestic domestic economy at the expense of other economies; (iv) While more price and wage flexibility exacerbates the risk of a deflationary global liquidity trap, it is the more rigid economies that bear the brunt of the recession; (v) (Safe) Public debt issuances and increases in government spending anywhere are expansionary everywhere, and more so when there is some degree of price or wage flexibility. We use our model to shed light on the evolution of global imbalances, interest rates, and exchange rates since the beginning of the global financial crisis.

Suggested Citation

  • Caballero, Ricardo & Farhi, Emmanuel & Gourinchas, Pierre-Olivier, 2015. "Global Imbalances and Currency Wars at the ZLB," CEPR Discussion Papers 10905, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:10905
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    References listed on IDEAS

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    6. Emmanuel Farhi & Ivan Werning, "undated". "Fiscal Multipliers: Liquidity Traps and Currency Unions," Working Paper 78556, Harvard University OpenScholar.
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    More about this item

    Keywords

    capital flows; current account; exhorbitant privilege; forward guidance; inflation rate; interest rates; liquidity and safety traps; recessions; reserve currency; safe assets; secular stagnation; Taylor rule; uncovered interest parity;
    All these keywords.

    JEL classification:

    • E0 - Macroeconomics and Monetary Economics - - General
    • F3 - International Economics - - International Finance
    • F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance
    • G1 - Financial Economics - - General Financial Markets

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