Working Paper: CEPR ID: DP12894
Authors: Luca Fornaro; Federica Romei
Abstract: This paper describes a paradox of global thrift. Consider a world in which interest rates are low and monetary policy is constrained by the zero lower bound. Now imagine that governments implement prudential financial and fiscal policies to stabilize the economy. We show that these policies, while effective from the perspective of individual countries, might backfi re if applied on a global scale. In fact, prudential policies generate a rise in the global supply of savings and a drop in global aggregate demand. Weaker global aggregate demand depresses output in countries at the zero lower bound. Due to this effect, non-cooperative financial and fiscal policies might lead to a fall in global output and welfare.
Keywords: liquidity traps; zero lower bound; capital flows; fiscal policies; macroprudential policies; current account policies; aggregate demand; externalities; international cooperation
JEL Codes: E32; E44; E52; F41; F42
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Implementation of national prudential policies (G28) | Increase in global supply of savings (F62) |
| Increase in global supply of savings (F62) | Decrease in global aggregate demand (F62) |
| Decrease in global aggregate demand (F62) | Depress output in countries at zero lower bound (E31) |
| Implementation of national prudential policies (G28) | Decrease in global aggregate demand (F62) |
| Decrease in global aggregate demand (F62) | Decline in global output and welfare (F62) |
| Implementation of national prudential policies (G28) | Decline in global output and welfare (F62) |