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Leverage and the Financial Accelerator in a Liquidity Trap

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  • Karel Mertens
  • Morten O. Ravn

Abstract

We show that the financial accelerator may be very large in a liquidity trap. We study a sticky price model with real estate and a financial friction specified as a collateral constraint. Expectations can lead the economy to a self-fulfilling liquidity trap equilibrium where the lower bound on the nominal interest rate binds. We model these equilibria as stochastic sunspots. As in the Great Depression, a liquidity trap entails house price depreciation and potentially large output losses. Higher leverage implies much larger output losses but at the same time rules out the existence of short-lived liquidity traps.

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File URL: http://www.aeaweb.org/articles.php?doi=10.1257/aer.101.3.413
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Bibliographic Info

Article provided by American Economic Association in its journal American Economic Review.

Volume (Year): 101 (2011)
Issue (Month): 3 (May)
Pages: 413-16

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Handle: RePEc:aea:aecrev:v:101:y:2011:i:3:p:413-16

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Cited by:
  1. Morten Ravn & Karel Mertens, 2011. "Credit Channels in a Liquidity Trap," 2011 Meeting Papers 1452, Society for Economic Dynamics.
  2. Julio A. CARRILLO & Celine POILLY, 2010. "On the Recovery Path during a Liquidity Trap: Do Financial Frictions Matter for Fiscal Multipliers?," Discussion Papers (IRES - Institut de Recherches Economiques et Sociales) 2010034, Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES).
  3. Karel Mertens & Morten Ravn, 2011. "The Research Agenda: Karel Mertens and Morten Ravn on Fiscal Policy, Anticipation Effects, Expectations and Crisis," EconomicDynamics Newsletter, Review of Economic Dynamics, vol. 12(2), April.
  4. Schnell, Fabian, 2013. "Can Monetary Policy Delay the Reallocation of Capital?," Economics Working Paper Series 1329, University of St. Gallen, School of Economics and Political Science.

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