Discussion paper

DP15631 Liquidity Traps in a World Economy

This paper studies a New Keynesian model of a two-country world with a zero lower bound (ZLB) constraint for nominal interest rates. A floating exchange rate regime is assumed. The presence of the ZLB generates multiple equilibria. The two countries can experience recurrent
liquidity traps induced by the self-fulfilling expectation that future inflation will be low. These “expectations-driven” liquidity traps can be synchronized or unsynchronized across countries. In an expectations-driven liquidity trap, the domestic and international transmission of persistent shocks to productivity and government purchases differs markedly from shock transmission in a “fundamentals-driven” liquidity trap.


Kollmann, R (2021), ‘DP15631 Liquidity Traps in a World Economy‘, CEPR Discussion Paper No. 15631. CEPR Press, Paris & London. https://cepr.org/publications/dp15631