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Liquidity Trap and Excessive Leverage

Author Info

  • Alp Simsek

    (Massachusetts Institute of Technology)

  • Anton Korinek

    (Johns Hopkins University and IMF)

Abstract

We investigate the role of debt market policies in mitigating liquidity traps driven by household leverage. When borrowers engage in deleveraging, the interest rate needs to fall to induce lenders to pick up the decline in aggregate demand. However, if the fall in the interest rate is limited by the zero lower bound, aggregate demand is insufficient and the economy enters a liquidity trap. In such an environment, households' borrowing and saving decisions are associated with aggregate demand externalities. The competitive equilibrium allocation is constrained inefficient. Welfare can be improved by ex-ante restrictions on leverage to mitigate prospective deleveraging. Ex-post policies to write down debt also generate positive demand externalities.

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File URL: https://economicdynamics.org/meetpapers/2013/paper_1369.pdf
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Paper provided by Society for Economic Dynamics in its series 2013 Meeting Papers with number 1369.

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Date of creation: 2013
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Handle: RePEc:red:sed013:1369
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Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

Web page: http://www.EconomicDynamics.org/
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Find related papers by JEL classification:
  • D14 - Microeconomics - - Household Behavior - - - Household Saving; Personal Finance
  • E23 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Production
  • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
  • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
  • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
  • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
  • E - Macroeconomics and Monetary Economics

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