Liquidity traps in a world economy

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