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On the optimal supply of liquidity with borrowing constraints

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  • Lippi, Francesco
  • Trachter, Nicholas

Abstract

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

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    1. Levine, David K., 1991. "Asset trading mechanisms and expansionary policy," Journal of Economic Theory, Elsevier, vol. 54(1), pages 148-164, June.
    2. Woodford, Michael, 1990. "The optimum quantity of money," Handbook of Monetary Economics, in: B. M. Friedman & F. H. Hahn (ed.), Handbook of Monetary Economics, edition 1, volume 2, chapter 20, pages 1067-1152, Elsevier.
    3. Veronica Guerrieri & Guido Lorenzoni, 2017. "Credit Crises, Precautionary Savings, and the Liquidity Trap," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 132(3), pages 1427-1467.
    4. 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.
    5. 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.
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    7. Timothy J. Kehoe & David K. Levine & Michael Woodford, 1990. "The optimum quantity of money revisited," Working Papers 404, Federal Reserve Bank of Minneapolis.
    8. Carlstrom, Charles T & Fuerst, Timothy S, 1997. "Agency Costs, Net Worth, and Business Fluctuations: A Computable General Equilibrium Analysis," American Economic Review, American Economic Association, vol. 87(5), pages 893-910, December.
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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.

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    More about this item

    Keywords

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

    JEL classification:

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

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