Revisiting the AA-DD model in Zero Lower Bound

Charles Olivier Mao Takongmo

MPRA Paper from University Library of Munich, Germany

Abstract: This paper proposes a simple model of a mechanism through which exchange rate can affect the link between output and government spending in zero lower bound (ZLB) periods. In our proposed model, the expected near-future interest rate is added as an endogenous variable. Unlike existing AA-DD models in ZLB, the nominal exchange rate is no longer constant. Our model predicts that the output effect of an increase in government spending in a ZLB period is deflected by an appreciation of the current exchange rate. The AA-DD model is taught in almost all economic departments. The model is also generally used by many central banks and governments. The existing AA-DD model can be misleading. Our new AA-DD model may help to update the existing model in ZLB periods. Our AA-DD model is also consistent with recent dynamic stochastic general equilibrium models in open economies in ZLB periods.

Keywords: Zero lower bound; The exchange rate; Government Spending. (search for similar items in EconPapers)
JEL-codes: E4 E62 F41 (search for similar items in EconPapers)
Date: 2019-01-29
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