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The Fiscal Multiplier and Spillover in a Global Liquidity Trap

  • 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))

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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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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