Global Imbalances and Currency Wars at the ZLB

68 Pages Posted: 28 Oct 2015

See all articles by Ricardo J. Caballero

Ricardo J. Caballero

Massachusetts Institute of Technology (MIT) - Department of Economics; National Bureau of Economic Research (NBER)

Emmanuel Farhi

Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

Pierre-Olivier Gourinchas

University of California, Berkeley - Department of Economics; University of California, Berkeley - Economic Analysis & Policy Group; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

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Date Written: October 2015

Abstract

This paper explores the consequences of extremely low equilibrium real interest rates in a world with integrated but heterogenous capital markets, and nominal rigidities. In this context, we establish five main results: (i) Economies experiencing liquidity traps pull others into a similar situation by running current account surpluses; (ii) Reserve currencies have a tendency to bear a disproportionate share of the global liquidity trap -- a phenomenon we dub the "reserve currency paradox;" (iii) Beggar-thy-neighbor exchange rate devaluations stimulate the domestic domestic economy at the expense of other economies; (iv) While more price and wage flexibility exacerbates the risk of a deflationary global liquidity trap, it is the more rigid economies that bear the brunt of the recession; (v) (Safe) Public debt issuances and increases in government spending anywhere are expansionary everywhere, and more so when there is some degree of price or wage flexibility. We use our model to shed light on the evolution of global imbalances, interest rates, and exchange rates since the beginning of the global financial crisis.

Keywords: capital flows, current account, exhorbitant privilege, forward guidance, inflation rate, interest rates, liquidity and safety traps, recessions, reserve currency, safe assets, secular stagnation, Taylor rule, uncovered interest parity

JEL Classification: E0, F3, F4, G1

Suggested Citation

Caballero, Ricardo J. and Farhi, Emmanuel and Gourinchas, Pierre-Olivier, Global Imbalances and Currency Wars at the ZLB (October 2015). CEPR Discussion Paper No. DP10905, Available at SSRN: https://ssrn.com/abstract=2682592

Ricardo J. Caballero (Contact Author)

Massachusetts Institute of Technology (MIT) - Department of Economics ( email )

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Emmanuel Farhi

Harvard University - Department of Economics ( email )

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Pierre-Olivier Gourinchas

University of California, Berkeley - Department of Economics ( email )

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University of California, Berkeley - Economic Analysis & Policy Group ( email )

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United States

HOME PAGE: http://sites.google.com/view/pgourinchas

National Bureau of Economic Research (NBER)

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HOME PAGE: http://www.nber.org/people/pierre-olivier_gourinchas

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