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The Safety Trap

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  • Ricardo J. Caballero
  • Emmanuel Farhi

Abstract

In this paper we provide a model of the macroeconomic implications of safe asset shortages. In particular, we discuss the emergence of a deflationary safety trap equilibrium with endogenous risk premia. It is an acute form of a liquidity trap, in which the shortage of a specific form of assets, safe assets, as opposed to a general shortage of assets, is the fundamental driving force. At the ZLB, our model has a Keynesian cross representation, in which net safe asset supply plays the role of an aggregate demand shifter. Essentially, safety traps correspond to liquidity traps in which the emergence of an endogenous risk premium significantly alters the connection between macroeconomic policy and economic activity. “Helicopter drops” of money, safe public debt issuances, swaps of private risky assets for safe public debt, or increases in the inflation target, stimulate aggregate demand and output, while forward guidance is less effective. The safety trap can be arbitrarily persistent, as in the secular stagnation hypothesis, despite the existence of infinitely lived assets.

Suggested Citation

  • Ricardo J. Caballero & Emmanuel Farhi, 2014. "The Safety Trap," NBER Working Papers 19927, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:19927
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    More about this item

    JEL classification:

    • E0 - Macroeconomics and Monetary Economics - - General
    • E1 - Macroeconomics and Monetary Economics - - General Aggregative Models
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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