International Spillover of Economic Fluctuations: A Dynamic Optimization Approach
25 Pages Posted: 1 May 2006
Date Written: February 2001
After the 1990 Japanese stock market crash the Japanese economy began to stagnate whereas the U.S. economy began to expand, yet the yen tended to appreciate against the dollar. Such a phenomenon is difficult to explain in conventional models. This paper examines its mechanism using a two-country dynamic model that accommodates a liquidity trap and unemployment. If the marginal utility of consumption relative to that of liquidity declines in a country, its current account improves, which appreciates the home currency against the foreign currency. Consequently, home products lose competitiveness, causing home employment to decrease and foreign employment to increase.
Keywords: persistent unemployment, exchange rate, current account
JEL Classification: F41, F42
Suggested Citation: Suggested Citation