The Safety Trap

Citation:

Caballero, Ricardo J, and Emmanuel Farhi. 2017. “The Safety Trap.” Review of Economic Studies 85 (1): 223-274.
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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. 

Last updated on 05/30/2018