The Safety Trap

By Ricardo J. Caballero, Emmanuel Farhi. 2017

362 citations recorded by the source corpus.

In this article, 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 Zero Lower Bound, 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.

Subfields: Finance

View Paper: https://www.semanticscholar.org/paper/fbc03fe58680adb269d308086743976fc01ac3fa

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Citations in the corpus

The Power of Forward Guidance Revisited (2016, neutral): “Caballero and Farhi (2014) argue that forward guidance is less effective if the reason why the zero lower bound binds is a shortage of safe assets in the economy—a safety trap—as opposed to a deleveraging or patience shock.”
On Secular Stagnation in the Industrialized World (2019, background): “Such policy may raise the short-run rate ((Caballero and Farhi, 2018)), whereas we focus on the long-run rate.”
A Model of Secular Stagnation (2014, background): “Caballero and Farhi (2014) contains some examples of how uncertainty may affect the natural rate of interest and thus trigger a liquidity trap.”
The Safe Assets Shortage Conundrum (2017, background): “In Caballero et al. (2015), we refer to this phenomenon as the paradox of the reserve currency.”
Wholesale Banking and Bank Runs in Macroeconomic Modeling of Financial Crises (2016, background): “Our framework also captures the buildup of safe assets prior to the crisis along with the subsequent collapse that a number of authors have emphasized (eg, Gorton and Metrick, 2015; Caballero and Farhi, 2015).”
A Behavioral New Keynesian Model (2020, neutral): “Caballero and Farhi (2017) offer a different explanation of the forward guidance puzzle in a model with a shortage of safe assets and endogenous risk premia.”
Safe Asset Scarcity and Aggregate Demand (2016, background): “Gennaioli, Shleifer and Vishny (2012), Barro and Mollerus (2014), Caballero and Farhi (2014), and Caballero et al. (2015)).”
Inequality and Aggregate Demand (2016, background): “10 Over the long run, it is motivated by the literature on secular stagnation (Eggertsson and Mehrotra (2014), Caballero et al. (2015)).”
Monetary Policy According to HANK (2018, neutral): “Our paper is also related to Caballero and Farhi (2014) which proposes an alternative framework in which the transmission of monetary policy works through general equilibrium effects on income and asset values.8 Finally, we solve the model in continuous time building on Achdou et al. (2014).”
Global trends in interest rates (2018, background): “…of LTCM, were key turning points in the emergence of global imbalances (e.g., Bernanke, 2005; Bernanke et al., 2011; Caballero and Krishnamurthy, 2009; Caballero, 2010; Caballero and Farhi, 2014; Caballero et al., 2015; Gourinchas and Rey, 2016; Hall, 2016; Caballero et al., 2017; Caballero, 2018).”
Investmentless Growth: An Empirical Investigation (2016, neutral): “Safe asset scarcity: Safe asset scarcity and/or changes in the composition of assets may affect corporations’ capital costs (see Caballero and Farhi [2014], for example).”
Pecuniary Externalities in Economies with Financial Frictions (2016, neutral): “For an elaboration of this point, see Dávila (2014). In more general stochastic settings, incomplete risk markets give rise to differences in marginal rates of substitution for different agents across multiple states of nature, and the planner can employ distributive effects to improve efficiency by”
Negative Nominal Interest Rates and the Bank Lending Channel (2019, neutral): “Summers 2014, Eggertsson and Mehrotra 2014 and Caballero and Farhi 2017). In a recent paper, Kiley and Roberts (2017) estimate that the ZLB will bind 30-40 percent of the time going forward.”