Fear of risk provides a rationale for protracted economic downturns.
We develop a real business cycle model where investors with decreasing
relative risk aversion choose between a risky and a safe technology
that exhibit decreasing returns. Because of a feedback effect
from the interest rate to risk aversion, two equilibria can emerge: a
standard equilibrium and a "safe" one in which investors invest in
safer assets. We refer to the dynamics of this second equilibrium as
a safety trap because it is self-reinforcing as investors accumulate
more wealth and show it to be consistent with Japan's lost decade.
American Economic Journal: Macroeconomics,
General Aggregative Models: Neoclassical
Macroeconomics: Consumption; Saving; Wealth
Capital; Investment; Capacity
Business Fluctuations; Cycles