Credit Crises and Liquidity Traps

Guido Lorenzoni () and Veronica Guerrieri
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Veronica Guerrieri: University of Chicago and Minneapolis Fed

No 1182, 2010 Meeting Papers from Society for Economic Dynamics

Abstract: In this paper, we argue that shocks that affect the private agents' ability to borrow are precisely the type of shocks that can push the economy in a liquidity trap. We show that, when preferences display prudence, these shocks tend to make consumers more cautious, leading both to lower levels of spending and to larger liquidity premia. Larger liquidity premia mean that the required real interest rate on highly liquid assets, like treasuries, tends to drop and can, possibly, go negative. This is what triggers a liquidity trap.

Date: 2010
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