Bubbles, the U.S. Interest Policy, and the Impact on Global Economic Growth: Reverse Growth Effects of Lower Interest Rates after Bubble Bursting

Abstract

This study analyzes the impact of the U.S. interest rate policy on the global economy. We extend the literature and build a global model consisting of a large country (the U.S.) and many small countries to investigate the mechanism by which economic growth and asset prices accelerate rapidly after a U.S. interest rate reduction. Specifically, we show that a U.S. interest rate reduction not only increases economic growth rates but also expands asset bubbles as long as the bubbles exist in small open economies. We also show, however, that this low interest rate policy has a large side effect, that is, a collapse of the asset bubbles causes a larger drop in the growth rate of small open countries than that in the case without a lower interest rate. This conclusion implies that small countries need to be prepared for overheated asset prices associated with U.S. interest policies.