This paper analyzes optimal policy responses to a global liquidity
trap. The key feature of this environment is that relative prices respond perversely. A fall in demand in one country causes an appreciation of its terms of trade, exacerbating the initial shock. At the zero bound, this country cannot counter this shock. Then it may be optimal for the partner country to raise interest rates. The partner may set a positive policy interest rate, even though its â€œnatural interest rateâ€ is below zero. An optimal policy response requires a mutual interaction between monetary and fiscal policy.
Cook, David, and Michael B. Devereux.
"Sharing the Burden: Monetary and Fiscal Responses to a World Liquidity Trap."
American Economic Journal: Macroeconomics,
General Aggregative Models: Keynes; Keynesian; Post-Keynesian
Business Fluctuations; Cycles
Financial Markets and the Macroeconomy
International Business Cycles