Debt Deleveraging and the Zero Bound: Potentially Perverse Effects of Real Exchange Rate Movements

Paul Luk () and David Vines

Working Papers from Hong Kong Institute for Monetary Research

Abstract: We present a microfounded two-country model of global imbalances and debt deleveraging. A sustained rise in saving in one country can lead to a worldwide fall in interest rates and an accumulation of debt in the other country. When a subsequent deleveraging shock occurs, interest rates are forced down further. In the presence of a zero bound to interest rates, the deleveraging country may face a combination of a large fall in output, deflation, a rise in real interest rates and real exchange rate appreciation. Such exchange rate appreciation will intensify the loss in output, magnify the deflation and further tighten the deleveraging constraint.

Keywords: Global Imbalances; Debt Deleveraging; Liquidity Trap; Real Exchange Rate Number: 202014 (search for similar items in EconPapers)
JEL-codes: E5 F3 (search for similar items in EconPapers)
Pages: 37 pages
Date: 2014-08
New Economics Papers: this item is included in nep-mac, nep-mon and nep-opm
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