DP12894 The Paradox of Global Thrift

Author(s): Luca Fornaro, Federica Romei
Publication Date: April 2018
Date Revised: June 2018
Keyword(s): aggregate demand externalities, Capital Flows, current account policies, fiscal policies, international cooperation, liquidity traps, macroprudential policies, zero lower bound
JEL(s): E32, E44, E52, F41, F42
Programme Areas: International Macroeconomics and Finance, Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=12894

This paper describes a paradox of global thrift. Consider a world in which interest rates are low and monetary policy is constrained by the zero lower bound. Now imagine that governments implement prudential financial and fiscal policies to stabilize the economy. We show that these policies, while effective from the perspective of individual countries, might backfire if applied on a global scale. In fact, prudential policies generate a rise in the global supply of savings and a drop in global aggregate demand. Weaker global aggregate demand depresses output in countries at the zero lower bound. Due to this effect, non-cooperative financial and fiscal policies might lead to a fall in global output and welfare.