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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 safeasset shortages. In particular, we discuss the emergence of a deflationary safety trap equilibrium with endogenous risk premia. It is an acuteform of a liquidity trap, in which the shortage of a specific form ofassets, safe assets, as opposed to a general shortage of assets, is thefundamental driving force. At the ZLB, our model has a Keynesian crossrepresentation, in which net safe asset supply plays the role of anaggregate demand shifter. Essentially, safety traps correspond to liquiditytraps in which the emergence of an endogenous risk premium significantlyalters the connection between macroeconomic policy and economic activity.``Helicopter drops'' of money, safe public debt issuances, swaps of privaterisky assets for safe public debt, or increases in the inflation target,stimulate aggregate demand and output, while forward guidance is lesseffective. The safety trap can be arbitrarily persistent, as in the secularstagnation hypothesis, despite the existence of infinitely lived assets.

Suggested Citation

  • Ricardo J Caballero & Emmanuel Farhi, "undated". "The Safety Trap," Working Paper 233766, Harvard University OpenScholar.
    • Handle: RePEc:qsh:wpaper:233766
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    File URL: http://scholar.harvard.edu/farhi/node/233766
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    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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