Global vs. Local Liquidity Traps

Cook, David E.; Devereux, Michael B.

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Global vs. Local Liquidity Traps

Seoul Journal of Economics, Vol. 24, No. 4, pp. 471-493, 2011

24 Pages Posted: 8 Dec 2011

See all articles by David E. Cook

David E. Cook

Hong Kong University of Science & Technology (HKUST) - Department of Economics; Hong Kong University of Science & Technology (HKUST) - Department of Economics

Michael B. Devereux

University of British Columbia (UBC) - Department of Economics; Centre for Economic Policy Research (CEPR)

Date Written: November 30, 2011

Abstract

This paper examines demand spillovers in a two country open economy model to a demand shock newline (emanating from a single, source country) sufficiently large to push one or both countries into a liquidity trap. The zero lower bound on nominal interest rates keeps the central bank in the source country from fully adjusting monetary policy. We describe a two country New Keynesian model with sufficient home bias so as to exclude symmetric movements in response to demand shocks. We study conditions under which a liquidity trap in one country might spillover to a trading partner. We study, under which conditions, a liquidity trap in one country will lead to a liquidity trap in another country. We also show conditions under which a liquidity trap in another country can spillover into an output expansion in a trading partner.

Keywords: Liquidity trap, Monetary policy, Fiscal policy, International spillovers

JEL Classification: E2, E5, E6

Suggested Citation: Suggested Citation

Cook, David E. and Devereux, Michael B., Global vs. Local Liquidity Traps (November 30, 2011). Seoul Journal of Economics, Vol. 24, No. 4, pp. 471-493, 2011, Available at SSRN: https://ssrn.com/abstract=1968748