The Safety Trap

Ricardo Caballero () and Emmanuel Farhi

The Review of Economic Studies, 2018, vol. 85, issue 1, 223-274

Abstract: In this article, 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 Zero Lower Bound, 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.

Keywords: Liquidity traps; Risk premia; Forward guidance; Quantitative easing; Unconventional; monetary policy; Helicopter drops (search for similar items in EconPapers)
JEL-codes: E4 E5 E6 G1 G2 (search for similar items in EconPapers)
Date: 2018
References: Add references at CitEc
Citations: View citations in EconPapers (61)

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Related works:
Working Paper: The Safety Trap (2015)
Working Paper: The Safety Trap (2014)
Working Paper: The Safety Trap
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Persistent link: https://EconPapers.repec.org/RePEc:oup:restud:v:85:y:2018:i:1:p:223-274.

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