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  3. American Economic Review
  4. May 2011
  5. Leverage and the Financial Accelerator in a Liquidity Trap

Leverage and the Financial Accelerator in a Liquidity Trap

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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.

Citation

Mertens, Karel, and Morten O. Ravn. 2011. "Leverage and the Financial Accelerator in a Liquidity Trap." American Economic Review, 101 (3): 413-16. DOI: 10.1257/aer.101.3.413

JEL Classification

  • D84 Expectations; Speculations
  • E32 Business Fluctuations; Cycles