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Bond Premium Cyclicality and Liquidity Traps

Sanjay Singh () and Nicolas Caramp ()

No 336, Working Papers from University of California, Davis, Department of Economics

Abstract: Safe asset shortages can expose the economy to liquidity traps. The nature of these traps is determined by the cyclicality of the bond premium. Self-fulfilling liquidity traps are associated with a counter-cyclical bond premium. Small issuances of government debt crowd out private debt and exacerbate these pessimism-driven recessions. In contrast, fundamental liquidity traps arise under a pro-cyclical bond premium and government debt is expansionary. In the data, we find evidence of a counter-cyclical bond premium and a pro-cyclical supply of safe assets. We propose robust policies that prevent the existence of self-fulfilling traps and are expansionary in fundamental traps.

Keywords: bond premium; endogenous safe assets; liquidity trap (search for similar items in EconPapers)
JEL-codes: E0 E1 E5 E32 E52 (search for similar items in EconPapers)
Pages: 67
Date: 2020-01-31
New Economics Papers: this item is included in nep-mac
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