Liquidity Trap and Excessive Leverage

Anton Korinek and Alp Simsek

No 2014/129, IMF Working Papers from International Monetary Fund

Abstract: 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.

Keywords: WP; aggregate demand; interest rate; contractionary monetary policy; liquidity trap; Leverage; zero lower bound; aggregate demand externality; efficiency; macroprudential policy; insurance; fire-sale externality; pecuniary externality; leveraging motive; Consumption; Income; Liquidity; Asset prices; Real interest rates (search for similar items in EconPapers)
Pages: 49
Date: 2014-07-21
References: Add references at CitEc
Citations: View citations in EconPapers (47)

Downloads: (external link)
http://www.imf.org/external/pubs/cat/longres.aspx?sk=41769 (application/pdf)

Related works:
Journal Article: Liquidity Trap and Excessive Leverage (2016)
Working Paper: Liquidity Trap and Excessive Leverage (2014)
Working Paper: Liquidity Trap and Excessive Leverage (2014)
Working Paper: Liquidity Trap and Excessive Leverage (2013)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:imf:imfwpa:2014/129

Ordering information: This working paper can be ordered from
http://www.imf.org/external/pubs/pubs/ord_info.htm

Access Statistics for this paper

More papers in IMF Working Papers from International Monetary Fund International Monetary Fund, Washington, DC USA. Contact information at EDIRC.
Bibliographic data for series maintained by Akshay Modi ().