The international forward guidance transmission under a global liquidity trap

TL;DR

This paper uses a two-country New Keynesian model to analyze how forward guidance affects international monetary policy transmission in a global liquidity trap, highlighting the importance of risk aversion and policy coordination.

Contribution

It demonstrates the effects of risk aversion on foreign policy spillovers and shows that coordinated forward guidance can benefit both countries in a liquidity trap scenario.

Findings

Higher risk aversion amplifies beggar-thy-neighbor effects.

Home country benefits from its own forward guidance under ZLB.

Coordination of forward guidance duration can be mutually beneficial.

Abstract

This paper quantitatively explores the interaction effect of forward guidance (FG) on international monetary policy transmission using a standard two-country new Keynesian model with a global liquidity trap. First, we show that the magnitude of the constant risk aversion coefficient (CRRA) is important in determining the beggar-thy-neighbor and prosper-thy-neighbor effects in foreign economies when the home country only faces the zero lower bound (ZLB) constraints. Second,we demonstrate that both countries may benefit from adopting only the home country's FG policies if the home central bank only faces the ZLB. Third, we find the potential benefit of the FG interaction effect between two countries. Thus, we document the possibility that home and foreign central banks can benefit from monetary policy coordination by adopting the same duration of FG quarters.