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Step away from the zero lower bound: Small open economies in a world of secular stagnation
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Step away from the zero lower bound: Small open economies in a world of secular stagnation

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  • Corsetti, Giancarlo
  • Mavroeidi, Eleonora
  • Thwaites, Gregory
  • Wolf, Martin

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.

Suggested Citation

  • Corsetti, Giancarlo & Mavroeidi, Eleonora & Thwaites, Gregory & Wolf, Martin, 2017. "Step away from the zero lower bound: Small open economies in a world of secular stagnation," LSE Research Online Documents on Economics 86153, London School of Economics and Political Science, LSE Library.
    • Handle: RePEc:ehl:lserod:86153
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    Cited by:

    1. Müller, Gernot & Kuester, Keith & Corsetti, Giancarlo, 2016. "The Case for Flexible Exchange Rates in a Great Recession," CEPR Discussion Papers 11432, C.E.P.R. Discussion Papers.
    2. Murota, Ryu-ichiro, 2022. "The effect of a decline in the world real interest rate on a small open economy experiencing persistent stagnation," Economics Letters, Elsevier, vol. 216(C).
    3. Olivier Jeanne, 2021. "Currency Wars, Trade Wars, and Global Demand," NBER Working Papers 29603, National Bureau of Economic Research, Inc.
    4. Kollmann, Robert, 2021. "Liquidity traps in a world economy," Journal of Economic Dynamics and Control, Elsevier, vol. 132(C).
    5. Giancarlo Corsetti & Keith Kuester & Gernot J. Müller, 2017. "Fixed on Flexible: Rethinking Exchange Rate Regimes after the Great Recession," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 65(3), pages 586-632, August.
    6. Martin Wolf, 2018. "Optimal Prudential Policy in Economies with Downward Wage Rigidity," Vienna Economics Papers vie1804, University of Vienna, Department of Economics.
    7. Marco Rojas, 2022. "Monetary Policy in Small Open Economies and the International Zero Lower Bound," Working Papers Central Bank of Chile 966, Central Bank of Chile.
    8. Wolf, Martin, 2020. "Pecuniary externalities in economies with downward wage rigidity," Journal of Monetary Economics, Elsevier, vol. 116(C), pages 219-235.
    9. Javier Bianchi & Louphou Coulibaly, 2021. "Liquidity Traps, Prudential Policies, and International Spillovers," Working Papers 780, Federal Reserve Bank of Minneapolis.
    10. Corsetti, Giancarlo & Kuester, Keith & Müller, Gernot J., 2017. "Fixed on flexible rethink exchange rate regimes after the Great Recession," LSE Research Online Documents on Economics 86154, London School of Economics and Political Science, LSE Library.
    11. Jean-Baptiste Michau, 2021. "Open Economy Secular Stagnation and Financial Integration," Working Papers 2021-19, Center for Research in Economics and Statistics.
    12. Martin Wolf, 2018. "Optimal Prudential Policy in Economies with Downward Wage Rigidity," Vienna Economics Papers 1804, University of Vienna, Department of Economics.
    13. Gerhard Rösl & Franz Seitz & Karl-Heinz Tödter, 2019. "The Cost of Overcoming the Zero Lower-Bound: A Welfare Analysis," Economies, MDPI, vol. 7(3), pages 1-18, July.
    14. Wolf, Martin, 2020. "Pecuniary externalities in economies with downward wage rigidity," Journal of Monetary Economics, Elsevier, vol. 116(C), pages 219-235.

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    More about this item

    Keywords

    Monetary policy; zero lower bound; deflation; depreciation; beggar-thy-neighbour; capital controls;
    All these keywords.

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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