Working Paper: NBER ID: w19970
Authors: Anton Korinek; Alp Simsek
Abstract: We investigate the role of macroprudential policies in mitigating liquidity traps driven by deleveraging, using a simple Keynesian model. When constrained agents engage in deleveraging, the interest rate needs to fall to induce unconstrained agents to pick up the decline in aggregate demand. However, if the fall in the interest rate is limited by the zero lower bound, aggregate demand is insufficient and the economy enters a liquidity trap. In such an environment, agents' ex-ante leverage and insurance decisions are associated with aggregate demand externalities. The competitive equilibrium allocation is constrained inefficient. Welfare can be improved by ex-ante macroprudential policies such as debt limits and mandatory insurance requirements. The size of the required intervention depends on the differences in marginal propensity to consume between borrowers and lenders during the deleveraging episode. In our model, contractionary monetary policy is inferior to macroprudential policy in addressing excessive leverage, and it can even have the unintended consequence of increasing leverage.
Keywords: No keywords provided
JEL Codes: E32; E44
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| constrained agents' deleveraging (G33) | fall in interest rates (E43) |
| fall in interest rates (E43) | increase in aggregate demand by unconstrained agents (E19) |
| zero lower bound (E49) | liquidity trap (E41) |
| constrained agents' deleveraging (G33) | liquidity trap (E41) |
| excessive leverage accumulation (G32) | negative aggregate demand externalities (D62) |
| negative aggregate demand externalities (D62) | inefficient welfare outcomes (D69) |
| macroprudential policies (E60) | improved welfare (I30) |
| contractionary monetary policy (E52) | increase in leverage (G32) |
| greater leverage (G32) | greater reductions in aggregate demand (E19) |
| greater leverage (G32) | deeper recessions (E32) |
| policies restricting leverage (G18) | mitigate negative effects (E71) |
| policies restricting leverage (G18) | enhance economic stability (E60) |