Working Paper: CEPR ID: DP9767
Authors: Pierpaolo Benigno; Salvatore Nistic
Abstract: This paper studies monetary policy in models where multiple assets have different liquidity properties: safe and "pseudo-safe" assets coexist. A shock worsening the liquidity properties of the pseudo-safe assets raises interest-rate spreads and can cause a deep recession cum deflation. Expanding the central bank's balance sheet fills the shortage of safe assets and counteracts the recession. Lowering the interest rate on reserves insulates market interest rates from the liquidity shock and improves risk sharing between borrowers and savers.
Keywords: liquidity crisis; unconventional policies; zero lower bound
JEL Codes: E30; E40; E50
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Deterioration of pseudosafe assets (E44) | Increased interest rate spreads (E43) |
| Increased interest rate spreads (E43) | Deep recession (E32) |
| Deep recession (E32) | Deflation (E31) |
| Expanding central bank's balance sheet (E58) | Alleviating shortage of safe assets (E44) |
| Alleviating shortage of safe assets (E44) | Counteracting recession (E65) |
| Lowering interest rate on reserves (E52) | Insulating market interest rates from liquidity shock (E43) |
| Insulating market interest rates from liquidity shock (E43) | Better risk sharing between borrowers and savers (G21) |
| Without central bank interventions (E49) | Significant downturns and increased borrowing costs (F65) |
| Significant downturns and increased borrowing costs (F65) | Contraction in nominal spending (E62) |