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Credit Crises, Precautionary Savings, and the Liquidity Trap

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  • Veronica Guerrieri
  • Guido Lorenzoni

Abstract

We study the effects of a credit crunch on consumer spending in a heterogeneous-agent incomplete-market model. After an unexpected permanent tightening in consumers’ borrowing capacity, some consumers are forced to deleverage and others increase their precautionary savings. This depresses interest rates, especially in the short run, and generates an output drop, even with flexible prices. The output drop is larger with nominal rigidities, if the zero lower bound prevents the interest rate from adjusting downwards. Adding durable goods to the model, households take larger debt positions and the output response may be larger.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 17583.

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Date of creation: Nov 2011
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Handle: RePEc:nbr:nberwo:17583

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