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The Safety Trap

Author

Listed:
  • Ricardo Caballero
  • Emmanuel Farhi

Abstract

Recently, the global economy has experienced recurrent episodes of safe asset shortages. In this paper we present a model that shows how such shortages can generate macroeconomic phenomena similar to those found in liquidity trap scenarios. Despite the similarities, there are also subtle but important differences which carry significant impacts on the relative effectiveness of economic policy and potential market solutions to the underlying problem. For example, while forward guidance policies are typically more effective than quantitative easing ones in the standard liquidity trap environment, the opposite holds in safety trap contexts. Also, while asset bubbles (market solutions) and public debt are both effective in liquidity traps, only the latter are in safety traps. Essentially, a safe asset shortage is a deficit of a particular form of wealth (safe wealth), which the government has comparative advantage in supplying. Forward guidance and financial bubbles, which increase risky wealth and stimulate the economy in liquidity traps, fail to do so in safety traps as they are dissipated through higher spreads.

Suggested Citation

  • Ricardo Caballero & Emmanuel Farhi, 2015. "The Safety Trap," Working Paper 146986, Harvard University OpenScholar.
  • Handle: RePEc:qsh:wpaper:146986
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    References listed on IDEAS

    as
    1. 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.
    2. Arvind Krishnamurthy & Annette Vissing-Jorgensen, 2011. "The Effects of Quantitative Easing on Interest Rates: Channels and Implications for Policy," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 42(2 (Fall)), pages 215-287.
    3. Ricardo J. Caballero & Emmanuel Farhi, 2013. "A Model of the Safe Asset Mechanism (SAM): Safety Traps and Economic Policy," Working Paper 70936, Harvard University OpenScholar.
    4. Emmanuel Farhi & Ivan Werning, "undated". "Fiscal Multipliers: Liquidity Traps and Currency Unions," Working Paper 78556, Harvard University OpenScholar.
    5. Anton Korinek & Alp Simsek, 2016. "Liquidity Trap and Excessive Leverage," American Economic Review, American Economic Association, vol. 106(3), pages 699-738, March.
    6. Robert J. Barro, 2014. "Safe Assets," Working Papers 2014-28, Economic Research Institute, Bank of Korea.
    7. Nicola Gennaioli & Andrei Shleifer & Robert Vishny, 2010. "Financial Innovation and Financial Fragility," NBER Chapters,in: Market Institutions and Financial Market Risk National Bureau of Economic Research, Inc.
    Full references (including those not matched with items on IDEAS)

    Citations

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    Cited by:

    1. Michelacci, Claudio & Paciello, Luigi, 2017. "Ambiguous Policy Announcements," CEPR Discussion Papers 11754, C.E.P.R. Discussion Papers.
    2. Athanasios Orphanides, 2017. "The Fiscal-Monetary Policy Mix in the Euro Area: Challenges at the Zero Lower Bound," European Economy - Discussion Papers 2015 - 060, Directorate General Economic and Financial Affairs (DG ECFIN), European Commission.
    3. Gary Gorton & Tyler Muir, 2016. "Mobile Collateral versus Immobile Collateral," NBER Working Papers 22619, National Bureau of Economic Research, Inc.
    4. Dániel Horváth & Róbert Szini, 2015. "The safety trap – the financial market and macroeconomic consequences of the scarcity of safe assets," Financial and Economic Review, Magyar Nemzeti Bank (Central Bank of Hungary), vol. 14(1), pages 111-138.
    5. Robert J. Barro, 2014. "Safe Assets," Working Papers 2014-28, Economic Research Institute, Bank of Korea.
    6. Azariadis, Costas & Bullard, James & Singh, Aarti & Suda, Jacek, 2015. "Incomplete Credit Markets and Monetary Policy," Working Papers 2015-12, University of Sydney, School of Economics, revised Feb 2017.
    7. Benjamin D. Keen & Alexander W. Richter & Nathaniel A. Throckmorton, 2017. "Forward Guidance And The State Of The Economy," Economic Inquiry, Western Economic Association International, vol. 55(4), pages 1593-1624, October.
    8. repec:cbh:journl:v:14:y:2015:i:1:p:111-138 is not listed on IDEAS
    9. repec:ucp:macann:doi:10.1086/696069 is not listed on IDEAS
    10. repec:nbr:nberch:13955 is not listed on IDEAS
    11. Gauti B. Eggertsson & Neil R. Mehrotra & Sanjay R. Singh & Lawrence H. Summers, 2016. "A Contagious Malady? Open Economy Dimensions of Secular Stagnation," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 64(4), pages 581-634, November.
    12. Patrizio Pagano & Massimo Sbracia, 2014. "The secular stagnation hypothesis: a review of the debate and some insights," Questioni di Economia e Finanza (Occasional Papers) 231, Bank of Italy, Economic Research and International Relations Area.
    13. Azariadis, Costas & Bullard, James B. & Singh, Aarti & Suda, Jacek, 2015. "Optimal Monetary Policy at the Zero Lower Bound," Working Papers 2015-10, Federal Reserve Bank of St. Louis.
    14. Gilles Le Garrec & Vincent Touzé, 2016. "Capital accumulation and the dynamic of secular stagnation," Documents de Travail de l'OFCE 2016-17, Observatoire Francais des Conjonctures Economiques (OFCE).
    15. Gertler, M. & Kiyotaki, N. & Prestipino, A., 2016. "Wholesale Banking and Bank Runs in Macroeconomic Modeling of Financial Crises," Handbook of Macroeconomics, Elsevier.
    16. Michele Lanotte & Giacomo Manzelli & Anna Maria Rinaldi & Marco Taboga & Pietro Tommasino, 2016. "Easier said than done? Reforming the prudential treatment of banks’ sovereign exposures," Questioni di Economia e Finanza (Occasional Papers) 326, Bank of Italy, Economic Research and International Relations Area.
    17. Luigi Bonatti, 2016. "Anemic economic growth in advanced economies: structural factors and the impotence of expansionary macroeconomic policies," DEM Working Papers 2016/11, Department of Economics and Management.

    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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