The Safety Trap

Ricardo Caballero () and Emmanuel Farhi

No 19927, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: In this paper we provide a model of the macroeconomic implications of safe asset shortages. In particular, we discuss the emergence of a deflationary safety trap equilibrium with endogenous risk premia. It is an acute form of a liquidity trap, in which the shortage of a specific form of assets, safe assets, as opposed to a general shortage of assets, is the fundamental driving force. At the ZLB, our model has a Keynesian cross representation, in which net safe asset supply plays the role of an aggregate demand shifter. Essentially, safety traps correspond to liquidity traps in which the emergence of an endogenous risk premium significantly alters the connection between macroeconomic policy and economic activity. “Helicopter drops” of money, safe public debt issuances, swaps of private risky assets for safe public debt, or increases in the inflation target, stimulate aggregate demand and output, while forward guidance is less effective. The safety trap can be arbitrarily persistent, as in the secular stagnation hypothesis, despite the existence of infinitely lived assets.

JEL-codes: E0 E1 E5 E52 (search for similar items in EconPapers)
Date: 2014-02
New Economics Papers: this item is included in nep-mac
Note: AP ME
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Published as Ricardo J Caballero & Emmanuel Farhi, 2018. "The Safety Trap," Review of Economic Studies, Oxford University Press, vol. 85(1), pages 223-274.

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Journal Article: The Safety Trap (2018)
Working Paper: The Safety Trap (2015)
Working Paper: The Safety Trap
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