Must-Read: Ricardo J. Caballero, Emmanuel Farhi, and Pierre-Olivier Gourinchas: Global Imbalances and Currency Wars at the ZLB

Must-Read: Ricardo J. Caballero, Emmanuel Farhi, and Pierre-Olivier Gourinchas: Global Imbalances and Currency Wars at the ZLB: “[What are] the consequences of extremely low equilibrium real interest rates in a world…

…with integrated but heterogenous capital markets, and nominal rigidities[?]…. (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 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.