Leverage and the Financial Accelerator in a Liquidity Trap
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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Volume (Year): 101 (2011)
Issue (Month): 3 (May)
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- Karel R. S. M. Mertens & Morten O. Ravn, 2014.
"Fiscal Policy in an Expectations-Driven Liquidity Trap,"
Review of Economic Studies,
Oxford University Press, vol. 81(4), pages 1637-1667.
- Mertens, Karel & Ravn, Morten O, 2010. "Fiscal Policy in an Expectations Driven Liquidity Trap," CEPR Discussion Papers 7931, C.E.P.R. Discussion Papers.
- Mertens, Karel & Ravn, Morten O, 2011. "Credit Channels in a Liquidity Trap," CEPR Discussion Papers 8322, C.E.P.R. Discussion Papers.