Step Away from the Zero Lower Bound: Small Open Economies in a World of Secular Stagnation

40 Pages Posted: 19 Jul 2017

See all articles by Giancarlo Corsetti

Giancarlo Corsetti

University of Cambridge; University of Rome III - Department of Economics; Centre for Economic Policy Research (CEPR)

Eleonora Mavroeidi

International Monetary Fund (IMF)

Gregory Thwaites

Bank of England - Monetary Analysis

Martin Wolf

Centre for Economic Policy Research (CEPR); University of Bonn; University of Vienna - Department of Economics; University of St. Gallen

Multiple version iconThere are 2 versions of this paper

Date Written: July 14, 2017

Abstract

We study how small open economies can escape from deflation and unemployment in a situation where the world economy is permanently depressed. Building on the framework of Eggertsson et al (2016), we show that the transition to full employment and at-target inflation requires real and nominal depreciation of the exchange rate. However, because of adverse income and valuation effects from real depreciation, the escape can be beggar thy self, raising employment but actually lowering welfare. We show that as long as the economy remains financially open, domestic asset supply policies or reducing the effective lower bound on policy rates may be ineffective or even counterproductive. However, closing domestic capital markets does not necessarily enhance the monetary authorities’ ability to rescue the economy from stagnation.

Keywords: Small open economy, secular stagnation, capital controls, optimal policy, zero lower bound

JEL Classification: F41, E62

Suggested Citation

Corsetti, Giancarlo and Mavroeidi, Eleonora and Thwaites, Gregory and Wolf, Martin and Wolf, Martin and Wolf, Martin and Wolf, Martin, Step Away from the Zero Lower Bound: Small Open Economies in a World of Secular Stagnation (July 14, 2017). Bank of England Working Paper No. 666, Available at SSRN: https://ssrn.com/abstract=3003877 or http://dx.doi.org/10.2139/ssrn.3003877

Giancarlo Corsetti (Contact Author)

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Gregory Thwaites

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Martin Wolf

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