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Liquidity Traps in a Monetary Union

Robert Kollmann ()

No 397, Globalization Institute Working Papers from Federal Reserve Bank of Dallas

Abstract: The closed economy macro literature has shown that a liquidity trap can result from the self-fulfilling expectation that future inflation and output will be low (Benhabib et al. (2001)). This paper investigates expectations-driven liquidity traps in a two-country New Keynesian model of a monetary union. In the model here, country-specific productivity shocks induce synchronized responses of domestic and foreign output, while country-specific aggregate demand shocks trigger asymmetric domestic and foreign responses. A rise in government purchases in an individual country lowers GDP in the rest of the union. The results here cast doubt on the view that, in the current era of ultra-low interest rates, a rise in fiscal spending by Euro Area (EA) core countries 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 (search for similar items in EconPapers)
JEL-codes: E3 E4 F2 F3 F4 (search for similar items in EconPapers)
Pages: 31
Date: 2020-08-25
New Economics Papers: this item is included in nep-dge, nep-mac, nep-mon and nep-opm
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Working Paper: Liquidity Traps in a Monetary Union (2020) Downloads
Working Paper: Liquidity Traps in a Monetary Union (2020) Downloads
Working Paper: Liquidity traps in a monetary union (2020) Downloads
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Persistent link: https://EconPapers.repec.org/RePEc:fip:feddgw:88643

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DOI: 10.24149/gwp397

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