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Safety Traps

  • Kenza Benhima
  • Baptiste Massenot

Fear of risk provides a rationale for protracted economic downturns. We develop a real business cycle model where investors with decreasing relative risk aversion choose between a risky and a safe technology that exhibit decreasing returns. Because of a feedback effect from the interest rate to risk aversion, two equilibria can emerge: a standard equilibrium and a "safe" one in which investors invest in safer assets. We refer to the dynamics of this second equilibrium as a safety trap because it is self-reinforcing as investors accumulate more wealth and show it to be consistent with Japan's lost decade.

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Article provided by American Economic Association in its journal American Economic Journal: Macroeconomics.

Volume (Year): 5 (2013)
Issue (Month): 4 (October)
Pages: 68-106

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Handle: RePEc:aea:aejmac:v:5:y:2013:i:4:p:68-106
Note: DOI: 10.1257/mac.5.4.68
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  17. Angeletos, George-Marios & Panousi, Vasia, 2009. "Revisiting the supply side effects of government spending," Journal of Monetary Economics, Elsevier, vol. 56(2), pages 137-153, March.
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