October 2009 (Revised November 2016)

The Effects of Foreign Shocks When Interest Rates are at Zero

Martin Bodenstein, Christopher J. Erceg, and Luca Guerrieri


In a two-country DSGE model, the effects of foreign demand shocks on the home country are greatly amplified if the home economy is constrained by the zero lower bound on policy interest rates. This result applies even to countries that are relatively closed to trade such as the United States. Departing from many of the existing closed-economy models, the duration of the liquidity trap is determined endogenously. Adverse foreign shocks can extend the duration of the trap, implying more contractionary effects for the home country. The home economy is more vulnerable to adverse foreign shocks if the neutral rate is low – consistent with "secular stagnation" – and trade openness is high.

Revised Paper DOI: https://doi.org/10.17016/IFDP.2016.983r

Original Version (PDF)

Original Full paper (screen reader version)

Keywords: Zero lower bound, spillover effects, DSGE models

PDF: Full Paper

Disclaimer: The economic research that is linked from this page represents the views of the authors and does not indicate concurrence either by other members of the Board's staff or by the Board of Governors. The economic research and their conclusions are often preliminary and are circulated to stimulate discussion and critical comment. The Board values having a staff that conducts research on a wide range of economic topics and that explores a diverse array of perspectives on those topics. The resulting conversations in academia, the economic policy community, and the broader public are important to sharpening our collective thinking.

Back to Top
Last Update: September 18, 2020