Credit Channels in a Liquidity Trap

Morten Ravn and Karel Mertens

No 8322, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: We study liquidity trap dynamics driven by nonfundamental shifts in expectations in a model with nominal rigidities, housing, credit frictions and a Taylor rule. Highly leveraged borrowing through nominal debt backed by real estate collateral greatly magnifies the decline in output and house prices during a liquidity trap recession. The amplification mechanism is much smaller when there is no feedback from house prices to the borrowing constraint, when debt is real rather nominal, and when leverage is small. We argue that the liquidity trap dynamics share some important features with the recent US recession and that high levels of leverage may have made the economy sensitive to expectations induced liquidity traps.

Keywords: Collateral constraint; Expectations; Housing; Leverage; Liquidity trap (search for similar items in EconPapers)
JEL-codes: E2 E3 E5 (search for similar items in EconPapers)
Date: 2011-04
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Citations: View citations in EconPapers (11)

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Working Paper: Credit Channels in a Liquidity Trap (2011)
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