Working Paper: CEPR ID: DP15631
Authors: Robert Kollmann
Abstract: This paper studies a New Keynesian model of a two-country world with a zero lower bound (ZLB) constraint for nominal interest rates. A floating exchange rate regime is assumed. The presence of the ZLB generates multiple equilibria. The two countries can experience recurrentliquidity traps induced by the self-fulfilling expectation that future inflation will be low. These “expectations-driven” liquidity traps can be synchronized or unsynchronized across countries. In an expectations-driven liquidity trap, the domestic and international transmission of persistent shocks to productivity and government purchases differs markedly from shock transmission in a “fundamentals-driven” liquidity trap.
Keywords: zero lower bound; expectations-driven liquidity traps; fundamentals-driven liquidity traps; domestic and international shock transmission; terms of trade; exchange rate; net exports
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 |
|---|---|
| Zero lower bound (ZLB) (E43) | expectations-driven liquidity traps (E41) |
| expectations-driven liquidity traps (E41) | recurrent liquidity traps (E19) |
| expectations-driven liquidity traps (E41) | self-fulfilling beliefs about low future inflation (E31) |
| self-fulfilling beliefs about low future inflation (E31) | binds zero lower bound (ZLB) constraint on nominal interest rates (E43) |
| expectations-driven liquidity traps (E41) | domestic shock transmissions (F42) |
| expectations-driven liquidity traps (E41) | international shock transmissions (F42) |
| positive shock to home productivity in expectations-driven liquidity trap (D84) | raises home output (E23) |
| positive shock to home productivity in expectations-driven liquidity trap (D84) | lowers foreign output (F69) |
| rise in home government purchases in expectations-driven liquidity trap (E62) | lowers home net exports (F69) |
| rise in home government purchases in expectations-driven liquidity trap (E62) | raises foreign output (E23) |
| persistent fiscal spending shocks in expectations-driven liquidity traps (E62) | smaller output multipliers (E23) |