Open Economy Secular Stagnation and Financial Integration

What is the optimal policy response to secular stagnation within a small open economy? Secular stagnation is characterized by a persistent lack of demand, resulting in under-employment. Within a small open economy, the degree of fi nancial integration determines the nature of the secular stagnation equilibrium. Under perfect capital mobility, stagnation is due to downward nominal wage rigidities; while under financial autarky, it is due to an excessively high real interest rate. I characterize the planners optimal allocation of resources and solve for the tax policy that implements it within a stagnating economy. Under perfect fi nancial integration, payroll taxes should be falling and labor income taxes rising such as to relax the downward nominal wage rigidity; while under fi nancial autarky, the opposite policy should be implemented such as to generate inflation. Alternatively, full employment can be achieved by setting a sufficiently inflation target and by relying on an exchange rate policy to import inflation from abroad. Policy options are more limited under a fixed exchange rate regime, where effciency can either be reached through a coordinated policy response or by abandoning the peg.