Pessimism Shocks in a Model of Global Macroeconomic Interdependence

Insights into the four-region strategic behaviour that drives global economic performance can be derived from applications of the elemental multi-region, macroeconomic simulation model introduced in this paper. It has a global general equilibrium structure that embodies bilateral linkages between represented regions via both trade and investment. Its behaviour is illustrated with an application to strategic monetary policy during the post-GFC period, which has been characterised by pessimistic expectations over prices, disposable income levels and capital returns in the US, the EU and Japan. The retention of full employment in the pessimistic regions is shown to require very considerable monetary expansions and these tend to flood the other regions with liquidity, temporarily raising their terms of trade, real consumption and investment while appreciating their real exchange rates. The results further suggest elements of coordination game structure amongst the big four economies in which equilibria are characterised by collective monetary responses, at least when subjected to pessimism shocks.