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Leverage and the Financial Accelerator in a Liquidity Trap

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  • Karel Mertens
  • Morten O. Ravn

Abstract

We show that the financial accelerator may be very large in a liquidity trap. We study a sticky price model with real estate and a financial friction specified as a collateral constraint. Expectations can lead the economy to a self-fulfilling liquidity trap equilibrium where the lower bound on the nominal interest rate binds. We model these equilibria as stochastic sunspots. As in the Great Depression, a liquidity trap entails house price depreciation and potentially large output losses. Higher leverage implies much larger output losses but at the same time rules out the existence of short-lived liquidity traps.

Suggested Citation

  • Karel Mertens & Morten O. Ravn, 2011. "Leverage and the Financial Accelerator in a Liquidity Trap," American Economic Review, American Economic Association, vol. 101(3), pages 413-416, May.
    • Handle: RePEc:aea:aecrev:v:101:y:2011:i:3:p:413-16
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    References listed on IDEAS

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    1. Matteo Iacoviello, 2005. "House Prices, Borrowing Constraints, and Monetary Policy in the Business Cycle," American Economic Review, American Economic Association, vol. 95(3), pages 739-764, June.
    2. Karel R. S. M. Mertens & Morten O. Ravn, 2014. "Fiscal Policy in an Expectations-Driven Liquidity Trap," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 81(4), pages 1637-1667.
    3. Ravn, Morten & Mertens, Karel, 2011. "Credit Channels in a Liquidity Trap," CEPR Discussion Papers 8322, C.E.P.R. Discussion Papers.
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    Cited by:

    1. Schnell, Fabian, 2013. "Can Monetary Policy Delay the Reallocation of Capital?," Economics Working Paper Series 1329, University of St. Gallen, School of Economics and Political Science.
    2. Julio Carrillo & Celine Poilly, 2013. "How do financial frictions affect the spending multiplier during a liquidity trap?," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 16(2), pages 296-311, April.
    3. Duchêne, Sébastien & Guerci, Eric & Hanaki, Nobuyuki & Noussair, Charles N., 2019. "The effect of short selling and borrowing on market prices and traders’ behavior," Journal of Economic Dynamics and Control, Elsevier, vol. 107(C), pages 1-1.
    4. Karel Mertens & Morten Ravn, 2011. "The Research Agenda: Karel Mertens and Morten Ravn on Fiscal Policy, Anticipation Effects, Expectations and Crisis," EconomicDynamics Newsletter, Review of Economic Dynamics, vol. 12(2), April.
    5. Jose Luis Nicolini Llosa, 2015. "Renta financiera y solvencia mundial," Ensayos de Economía 14143, Universidad Nacional de Colombia Sede Medellín.
    6. Salvatore Perdichizzi, 2017. "Estimating Fiscal multipliers in the Eurozone. A Nonlinear Panel Data Approach," DISCE - Working Papers del Dipartimento di Economia e Finanza def058, Università Cattolica del Sacro Cuore, Dipartimenti e Istituti di Scienze Economiche (DISCE).
    7. Andrea Boitani & Salvatore Perdichizzi, 2018. "Public Expenditure Multipliers in recessions. Evidence from the Eurozone," DISCE - Working Papers del Dipartimento di Economia e Finanza def068, Università Cattolica del Sacro Cuore, Dipartimenti e Istituti di Scienze Economiche (DISCE).
    8. Karel R. S. M. Mertens & Morten O. Ravn, 2014. "Fiscal Policy in an Expectations-Driven Liquidity Trap," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 81(4), pages 1637-1667.
    9. Carbajal-De-Nova, Carolina & Venegas-Martínez, Francisco, 2019. "On the paradigm shift of asset pricing models, before and after the global financial crisis: a literature review," Panorama Económico, Escuela Superior de Economía, Instituto Politécnico Nacional, vol. 15(29), pages 7-38, Primer se.
    10. Smets, Frank & Villa, Stefania, 2016. "Slow recoveries: Any role for corporate leverage?," Journal of Economic Dynamics and Control, Elsevier, vol. 70(C), pages 54-85.
    11. Ravn, Morten & Mertens, Karel, 2011. "Credit Channels in a Liquidity Trap," CEPR Discussion Papers 8322, C.E.P.R. Discussion Papers.

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