Working Paper: NBER ID: w19927
Authors: Ricardo J. Caballero; Emmanuel Farhi
Abstract: In this paper we provide a model of the macroeconomic implications of safe asset shortages. In particular, we discuss the emergence of a deflationary safety trap equilibrium with endogenous risk premia. It is an acute form of a liquidity trap, in which the shortage of a specific form of assets, safe assets, as opposed to a general shortage of assets, is the fundamental driving force. At the ZLB, our model has a Keynesian cross representation, in which net safe asset supply plays the role of an aggregate demand shifter. Essentially, safety traps correspond to liquidity traps in which the emergence of an endogenous risk premium significantly alters the connection between macroeconomic policy and economic activity. “Helicopter drops” of money, safe public debt issuances, swaps of private risky assets for safe public debt, or increases in the inflation target, stimulate aggregate demand and output, while forward guidance is less effective. The safety trap can be arbitrarily persistent, as in the secular stagnation hypothesis, despite the existence of infinitely lived assets.
Keywords: Safe Assets; Liquidity Trap; Macroeconomic Policy; Risk Premia; Deflation
JEL Codes: E0; E1; E5; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| shortage of safe assets (E44) | deflationary safety trap (E31) |
| shortage of safe assets (E44) | drop in safe interest rates (E43) |
| drop in safe interest rates (E43) | rise in risk premia (G19) |
| rise in risk premia (G19) | transfer of resources from risk-averse agents to risk-neutral agents (D81) |
| deflationary safety trap (E31) | reduced demand for safe assets (G19) |
| reduced demand for safe assets (G19) | lower output and income (E25) |
| lower output and income (E25) | reduced demand for safe assets (G19) |
| helicopter drops of money (E49) | stimulate aggregate demand (E00) |
| public debt issuances (H63) | stimulate aggregate demand (E00) |
| forward guidance (E60) | less effective in safety traps (J28) |