Liquidity Trap and Excessive Leverage

 
Author/Editor: Anton Korinek ; Alp Simsek
 
Publication Date: July 21, 2014
 
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Disclaimer: This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate
 
Summary: We investigate the role of macroprudential policies in mitigating liquidity traps driven by deleveraging, using a simple Keynesian model. When constrained agents engage in deleveraging, the interest rate needs to fall to induce unconstrained agents 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, agents' exante leverage and insurance decisions are associated with aggregate demand externalities. The competitive equilibrium allocation is constrained inefficient. Welfare can be improved by ex-ante macroprudential policies such as debt limits and mandatory insurance requirements. The size of the required intervention depends on the differences in marginal propensity to consume between borrowers and lenders during the deleveraging episode. In our model, contractionary monetary policy is inferior to macroprudential policy in addressing excessive leverage, and it can even have the unintended consequence of increasing leverage.
 
Series: Working Paper No. 14/129
Subject(s): Macroprudential Policy | Monetary policy | Liquidity | Demand | Borrowing | Debt markets | Economic recession | Equilibrium. Econometric models

 
English
Publication Date: July 21, 2014
ISBN/ISSN: 9781498370943/1018-5941 Format: Paper
Stock No: WPIEA2014129 Pages: 49
Price:
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