Author(s)

Charles O. Mao Takongmo

Department of Business Administration, Lévis Campus, University of Quebec at Rimouski, Lévis, Canada.

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.

The AA-DD Model, Zero Lower Bound, the Exchange Rate, Government Spending

Mao Takongmo, C. (2023) Revisiting the AA-DD Model in Zero Lower Bound. Theoretical Economics Letters, 13, 297-309. doi: 10.4236/tel.2023.132019.