Working Paper: NBER ID: w16867
Authors: Ippei Fujiwara; Tomoyuki Nakajima; Nao Sudo; Yuki Teranishi
Abstract: In this paper we consider a two-country New Open Economy Macroeconomics model, and analyze the optimal monetary policy when countries cooperate in the face of a "global liquidity trap" - i.e., a situation where the two countries are simultaneously caught in liquidity traps. Compared to the closed economy case, a notable feature of the optimal policy in the face of a global liquidity trap is its international dependence. Whether or not a country's nominal interest rate is hitting the zero bound affects the target inflation rate of the other country. The direction of the effect depends on whether goods produced in the two countries are Edgeworth complements or substitutes. We also compare several classes of simple interest-rate rules. Our finding is that targeting the price level yields higher welfare than targeting the inflation rate, and that it is desirable to let the policy rate of each country respond not only to its own price level and output gap, but also to those in the other country.
Keywords: liquidity trap; monetary policy; international cooperation
JEL Codes: E5; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Nominal interest rate in one country hits zero bound (E43) | Target inflation rate in another country (E31) |
| Choice of policy framework (D78) | Welfare outcomes (I38) |
| Policy rate responds to own conditions and conditions in another country (E43) | Optimal monetary policy in global liquidity trap (E63) |