Working Paper: CEPR ID: DP15148
Authors: Robert Kollmann
Abstract: The closed economy macro literature has shown that a liquidity trap can result from the self-fulfillingexpectation that future inflation and output will be low (Benhabib et al. (2001)). Thispaper investigates expectations-driven liquidity traps in a two-country New Keynesian model ofa monetary union. In the model here, country-specific productivity shocks induce synchronizedresponses of domestic and foreign output, while country-specific aggregate demand shockstrigger asymmetric domestic and foreign responses. A rise in government purchases in anindividual country lowers GDP in the rest of the union. The result here cast doubt on the viewthat, in the current era of ultra-low interest rates, a rise in fiscal spending by Euro Area (EA) corecountries would significantly boost GDP in the EA periphery (e.g. Blanchard et al. (2016)).
Keywords: zero lower bound; liquidity trap; monetary union; terms of trade; international fiscal spillovers; euro area
JEL Codes: E3; E4; F2; F3; F4
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Government purchases in an individual country (H59) | GDP in the rest of the union (O52) |
| Government purchases in an individual country (H59) | Local GDP (E20) |
| Local GDP (E20) | Foreign GDP (F29) |
| Negative transmission of home government spending (H59) | Foreign GDP (F29) |
| Expectations-driven liquidity traps (E41) | Fiscal multipliers (E62) |