The Effects of Foreign Shocks When Interest Rates are at Zero

55 Pages Posted: 14 Nov 2010

See all articles by Martin Bodenstein

Martin Bodenstein

Board of Governors of the Federal Reserve System

Christopher J. Erceg

Board of Governors of the Federal Reserve System

Luca Guerrieri

Board of Governors of the Federal Reserve System

Multiple version iconThere are 3 versions of this paper

Date Written: September 2010

Abstract

In a two-country DSGE model, the effects of foreign demand shocks on the home country are greatly amplified if the home economy is constrained by the zero lower bound for policy interest rates. This result applies even to countries that are relatively closed to trade such as the United States. Departing from many of the existing closed-economy models, the duration of the liquidity trap is determined endogenously. Adverse foreign shocks can extend the duration of the trap, implying more contractionary effects for the home country; conversely, large positive shocks can prompt an early exit, implying effects that are closer to those when the zero bound constraint is not binding.

Keywords: DSGE models, spillover effects, zero lower bound

JEL Classification: F32, F41

Suggested Citation

Bodenstein, Martin and Erceg, Christopher J. and Guerrieri, Luca, The Effects of Foreign Shocks When Interest Rates are at Zero (September 2010). CEPR Discussion Paper No. DP8006, Available at SSRN: https://ssrn.com/abstract=1707896

Martin Bodenstein (Contact Author)

Board of Governors of the Federal Reserve System ( email )

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Christopher J. Erceg

Board of Governors of the Federal Reserve System ( email )

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202-736-5638 (Fax)

Luca Guerrieri

Board of Governors of the Federal Reserve System ( email )

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Washington, DC 20551
United States
202-452-2550 (Phone)

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