1. By Soyoung Kim Seoul National University
Discussion on “International Monetary and Fiscal Policy Coordination in a Liquidity Trap” by Cook and Devereux
By Soyoung Kim
Seoul National University

2. Model Features Model Shocks Policy
government consumption in utility function (additively separable), government consumes only home goods
home bias in consumption is allowed.
no investment, no capital accumulation
two country, complete international financial markets
Shocks
demand shocks (preference - discount rate shocks)
fiscal shocks (government consumption shocks)
Policy
monetary policy (Taylor rule, and so on)
fiscal policy: subsidy to producers and government consumption with lump sum taxation

3. Main Findings
International Transmission of Liquidity Trap: Demand shocks giving rise to a liquidity trap in one country are transferred to other countries through international financial markets.
Effects of Fiscal Policy in a Liquidity Trap: Fiscal expansion has a much greater effect on domestic GDP in a liquidity trap than in normal times, but it does so in a beggar-thy-neighbor fashion.
Optimal Global Monetary and Fiscal Policy Coordination: The paper finds only a limited welfare role for using fiscal policy to exit a liquidity trap and only a modest case for coordinated global fiscal expansion.

4. Effects of Fiscal Policy in the Model
Fiscal expansion has a much greater effect on domestic GDP in a liquidity trap than in normal times.
The fiscal multiplier in a liquidity trap is magnified even further in the open economy case.
In normal times, fiscal expansion appreciates the terms of trade (or real exchange rate), worsens the trade balance, and has a positive international spillover effect.
In a liquidity trap, fiscal expansion depreciates the terms of trade, improves the trade balance and has a negative international spillover effect. This result is also a key to understand why there is only modest case for coordinated global fiscal expansion.
In the analysis, expenditure switching effect (through changes in terms of trade and the trade balance) is emphasized as the key international transmission mechanism of fiscal policy.

5. Empirical Effects of Fiscal Policy
What are the effects of fiscal policy in open economies in the empirical literature? Is the prediction of current model consistent with the empirical evidence?
Do government consumption shocks appreciate the terms of trade (or real exchange rate) and worsen the trade balance (or current account) in normal times?
Is the expenditure switching effect the key international transmission mechanism of fiscal policy?
We don’t have much evidence on the effects of fiscal policy in a liquidity trap.

6. US result, recursive and non-recursive VAR’s, taken from
Figures 5 and 7, Kim and Roubini (2008), Journal of International Economics

7. Recursive VAR, taken from Table 2, Corsetti and Muller (2006), Economic Policy

8. Panel VAR, taken from
Figure 1, Ravn, Schmitt-Grohe, and Uribe (2008), Working Paper

9. VAR with sign restrictions, US, taken from Figure 3, Enders, Muller, and Scholl (2010), Working Paper

10. RER depreciation is found in majority of countries.
Real exchange rate and trade balance respond in opposite directions in majority of countries: expenditure-switching effect is not the main international transmission mechanism of fiscal policy
19 OECD Countries, Recursive VAR, modified from Table 1, Kim (2010), Working Paper

11. Summary and Implications
Recent empirical studies show that a positive government consumption shock tends to depreciate TOT and RER in normal times, contrary to the predictions of many traditional models and the model in the paper.
Kim and Roubini (2008), Kim (2010), Corsetti and Muller (2006), Ravn, Uribe-Schmitt-Grohe (2008), Kim (2010)…
In response to a positive government consumption shock, RER and TB move in opposite directions, which implies that expenditure switching effect may not be the main international transmission mechanism of government spending shocks: Kim (2010).
Although the model in this paper incorporates some popular features that are often used in past studies, it does not seem consistent with recent empirical evidence. In this sense, some of the main results might be questionable.

12. The Role of International Financial Markets
What would happen under incomplete financial market (for example, bonds-only economy)?
The hypothesis of complete international financial market is often rejected in past empirical studies.
By comparing to the results under incomplete international financial markets, we may better understand the role of complete international financial markets in the current analysis.
Liquidity traps may be less likely to be propagated across countries in incomplete financial market. If so, the authors may suggest that types of international financial markets are important in the propagation of liquidity traps.
Effects of fiscal policy are likely to be different in incomplete markets. Trade balance worsening may be more likely under temporary government consumption shocks.

13. Others
It may be worthwhile to show welfare-based measures in some cases. For example, does fiscal expansion in the home country worsen welfare of the foreign country in a liquidity trap?
Deficit-financed government consumption changes
Investment and production, government investment