Fisherian Debt-Deflation Zero Lower Bound

Dan Cao, Guangyu Nie and Wenlan Luo
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Dan Cao: Georgetown University
Wenlan Luo: Tsinghua University

No 961, 2019 Meeting Papers from Society for Economic Dynamics

Abstract: In this paper, we build a nonlinear two-sector DSGE model with capital accumulation, in which the Zero Lower Bound (ZLB) of interest rate and the collateral constraint are occasionally binding. We show the interaction of ZLB and the deleveraging cycle triggered by a binding collateral constraint can be a powerful mechanism in exacerbating the financial crisis as well as generating the prolonged liquidity trap and stagnation after the crisis. In particular, a binding ZLB can be triggered by capital over-accumulation, and when ZLB is binding, output is decreasing in capital stock. We also find an equilibrium does not exist when the capital stock is too high, while the existence of equilibrium can be restored by adding the adjustment cost of capital into the model. In our numerical results, we find the amplification effect of the collateral constraint is modest when the ZLB is not binding, but is quantitatively large when the ZLB is binding. In addition, with collateral constraint and ZLB, the recovery of the economy is slow since it takes longer for the borrowers to restore their net worth, and due to insufficient demand, the duration of the liquidity trap is longer. Lastly, in a society with better access to the credit market, the borrowers use higher leverage ex ante, and the average duration of ZLB is longer once the economy is hit by adverse shocks.

Date: 2019
New Economics Papers: this item is included in nep-ban, nep-dge and nep-mac
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