Working Paper: CEPR ID: DP8890
Authors: Francesco Lippi; Nicholas Trachter
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; Heterogeneous Agents; Incomplete Markets; Liquidity; Precautionary Savings; State Dependent Policy
JEL Codes: E5
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| liquidity provision (E41) | economic dynamics (P42) |
| increase in liquidity (E41) | insurance to agents during unproductive periods (G52) |
| increase in liquidity (E41) | dampening production incentives (D22) |
| length of unproductive periods (C41) | effectiveness of liquidity provision (E44) |
| state-dependent policy (H73) | benefits during recessions (J65) |
| state-dependent policy (H73) | contraction during expansions (E32) |
| optimal policy (C61) | trade-off between insurance and production costs (G52) |