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On the optimal supply of liquidity with borrowing constraints


  • Lippi, Francesco
  • Trachter, Nicholas


We characterize policies for the supply of liquidity in an economy where agents have a precautionary savings motive due to random production opportunities and the presence of borrowing constraints. We show that a socially efficient provision of liquidity involves a trade-off between insurance and production incentives. Two scenarios are studied: if no aggregate information is available to the policy maker, constant flat expansions are socially beneficial if unproductive spells are sufficiently long. If some aggregate information is available, a socially beneficial state-dependent policy prescribes expanding the supply of liquidity in recessions and contracting it in expansions.

Suggested Citation

  • Lippi, Francesco & Trachter, Nicholas, 2012. "On the optimal supply of liquidity with borrowing constraints," CEPR Discussion Papers 8890, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:8890

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    References listed on IDEAS

    1. Levine, David K., 1991. "Asset trading mechanisms and expansionary policy," Journal of Economic Theory, Elsevier, vol. 54(1), pages 148-164, June.
    2. Veronica Guerrieri & Guido Lorenzoni, 2017. "Credit Crises, Precautionary Savings, and the Liquidity Trap," The Quarterly Journal of Economics, Oxford University Press, vol. 132(3), pages 1427-1467.
    3. Ricardo Lagos & Randall Wright, 2005. "A Unified Framework for Monetary Theory and Policy Analysis," Journal of Political Economy, University of Chicago Press, vol. 113(3), pages 463-484, June.
    4. Chiu, Jonathan & Molico, Miguel, 2010. "Liquidity, redistribution, and the welfare cost of inflation," Journal of Monetary Economics, Elsevier, vol. 57(4), pages 428-438, May.
    5. Fernandes, Ana & Phelan, Christopher, 2000. "A Recursive Formulation for Repeated Agency with History Dependence," Journal of Economic Theory, Elsevier, vol. 91(2), pages 223-247, April.
    6. Timothy J. Kehoe & David K. Levine & Michael Woodford, 1990. "The optimum quantity of money revisited," Working Papers 404, Federal Reserve Bank of Minneapolis.
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    Cited by:

    1. Yuliy Sannikov & Markus Brunnermeier, 2012. "The I Theory of Money," 2012 Meeting Papers 411, Society for Economic Dynamics.

    More about this item


    Friedman rule; Heterogenous agents; Incomplete markets; Liquidity; Precautionary savings; State dependent policy.;

    JEL classification:

    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit

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