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On the optimal supply of liquidity with borrowing constraints

Francesco Lippi and Nicholas Trachter

No 8890, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We characterize policies for the supply of liquidity in an economy where agents have a precautionary savings motive due to random production opportunities and the presence of borrowing constraints. We show that a socially efficient provision of liquidity involves a trade-off between insurance and production incentives. Two scenarios are studied: if no aggregate information is available to the policy maker, constant flat expansions are socially beneficial if unproductive spells are sufficiently long. If some aggregate information is available, a socially beneficial state-dependent policy prescribes expanding the supply of liquidity in recessions and contracting it in expansions.

Keywords: Friedman rule; Heterogenous agents; Incomplete markets; Liquidity; Precautionary savings; State dependent policy. (search for similar items in EconPapers)
JEL-codes: E5 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cta, nep-dge, nep-mac and nep-mon
Date: 2012-03
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