TITLE:
Revisiting the AA-DD Model in Zero Lower Bound
AUTHORS:
Charles O. Mao Takongmo
KEYWORDS:
The AA-DD Model, Zero Lower Bound, the Exchange Rate, Government Spending
JOURNAL NAME:
Theoretical Economics Letters,
Vol.13 No.2,
April
24,
2023
ABSTRACT: This paper proposes a simple model of a mechanism
through which exchange rate can affect the link between output and government
spending in zero lower bound (ZLB) periods. In our proposed model, the expected
near-future interest rate is added as an endogenous variable. Unlike existing
AA-DD models in ZLB, the nominal exchange rate is no longer constant. Our model
predicts that the output effect of an increase in government spending in a ZLB
period is deflected by an appreciation of the current exchange rate. The AA-DD
model is taught in almost all economic departments. The model is also generally
used by many central banks and governments. The existing AA-DD model can be
misleading. Our new AA-DD model may help to update the existing model in ZLB
periods. Our AA-DD model is also consistent with recent dynamic stochastic
general equilibrium models in open economies in ZLB periods.