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Title: Global Imbalances and Currency Wars at the ZLB

Author(s): Ricardo Caballero, Emmanuel Farhi and Pierre-Olivier Gourinchas

Publication Date: October 2015

Keyword(s): capital flows, current account, exhorbitant privilege, forward guidance, inflation rate, interest rates, liquidity and safety traps, recessions, reserve currency, safe assets, secular stagnation, Taylor rule and uncovered interest parity

Programme Area(s): Financial Economics, International Macroeconomics and Finance and Monetary Economics and Fluctuations

Abstract: This paper explores the consequences of extremely low equilibrium real interest rates in a world with integrated but heterogenous capital markets, and nominal rigidities. In this context, we establish five main results: (i) Economies experiencing liquidity traps pull others into a similar situation by running current account surpluses; (ii) Reserve currencies have a tendency to bear a disproportionate share of the global liquidity trap?a phenomenon we dub the "reserve currency paradox;" (iii) Beggar-thy-neighbor exchange rate devaluations stimulate the domestic domestic economy at the expense of other economies; (iv) While more price and wage flexibility exacerbates the risk of a deflationary global liquidity trap, it is the more rigid economies that bear the brunt of the recession; (v) (Safe) Public debt issuances and increases in government spending anywhere are expansionary everywhere, and more so when there is some degree of price or wage flexibility. We use our model to shed light on the evolution of global imbalances, interest rates, and exchange rates since the beginning of the global financial crisis.

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Bibliographic Reference

Caballero, R, Farhi, E and Gourinchas, P. 2015. 'Global Imbalances and Currency Wars at the ZLB'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=10905