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This paper describes a paradox of global thrift. Consider a world in which interest rates are low and monetary policy is constrained by the zero lower bound. Now imagine that governments implement prudential financial and fiscal policies to stabilize the economy. We show that these policies, while effective from the perspective of individual countries, might backfire if applied on a global scale. In fact, prudential policies generate a rise in the global supply of savings and a drop in global aggregate demand. Weaker global aggregate demand depresses output in countries at the zero lower bound. Due to this effect, noncooperative financial and fiscal policies might lead to a fall in global output and welfare. Luca Fornaro acknowledges financial support from the Spanish Ministry of Economy, Industry and Competitiveness, through the Severo Ochoa Programme for Centres of Excellence in R&D (SEV-2015-0563) and grant ECO2016-79823-P (AEI/FEDER, UE), the European Union’s Horizon 2020 Research and Innovation Programme under Grant Agreement no. 649396, the Cerca Programme (Generalitat de Catalunya) and the Barcelona GSE Seed Grant. Federica Romei acknowledges financial support from the Fellowship Visiting program 2017–2018 at the Banco de España. |
