Discussion paper
DP18904 The International Transmission of Asset Market Shocks in Liquidity Traps
We build a two-country heterogenous-agent non-Ricardian model featuring asset scarcity and financial frictions in international capital markets. Due to the non-Ricardian nature of our framework, a demand for liquidity emerges and the supply of bonds matters. We show that shocks affecting the supply or demand of assets have very different international spillovers for an economy in a liquidity trap. A decrease in the supply of assets issued abroad leads to an asset shortage domestically. In normal times, the nominal interest rate decreases, stimulating investment and output. In a liquidity trap, deflation hits instead and the currency appreciates, causing a recession.
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