This paper presents a two-country model of the world economy with money and nominal stickiness in which countries may be affected by demand shocks. We show that a negative demand shock in one country may push the world economy in a global liquidity trap with unemployment and zero nominal interest rates in both countries. Global monetary stimulus (a temporary increase in both countries ’ inflation targets) may restore the first-best level of employment and welfare. Fiscal stimulus may restore full employment but distorts the allocation of consumption between private and public goods. We also study the international spillovers associated with each policy, and the risk that they lead to trade protectionism. 1
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