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Debt Deleveraging and the Zero Bound: Potentially Perverse Effects of Real Exchange Rate Movements

Listed author(s):
  • Paul Luk

    (Oxford University and Hong Kong Institute for Monetary Research)

  • David Vines

    (Oxford University and Centre for Applied Macroeconomic Analysis and Australian National University and Centre for Economic Policy Research)

Registered author(s):

    We present a microfounded two-country model of global imbalances and debt deleveraging. A sustained rise in saving in one country can lead to a worldwide fall in interest rates and an accumulation of debt in the other country. When a subsequent deleveraging shock occurs, interest rates are forced down further. In the presence of a zero bound to interest rates, the deleveraging country may face a combination of a large fall in output, deflation, a rise in real interest rates and real exchange rate appreciation. Such exchange rate appreciation will intensify the loss in output, magnify the deflation and further tighten the deleveraging constraint.

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    File URL: http://www.hkimr.org/uploads/publication/392/wp-no-20_2014-final-.pdf
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    Paper provided by Hong Kong Institute for Monetary Research in its series Working Papers with number 202014.

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    Length: 37 pages
    Date of creation: Aug 2014
    Handle: RePEc:hkm:wpaper:202014
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