Leverage and the Financial Accelerator in a Liquidity Trap
American Economic Review · 2011 · Volume 101 · Issue 3
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.
Keywords
Expectations, Speculations, Business Fluctuations, Cycles
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