Credit Channels in a Liquidity Trap

36 Pages Posted: 18 Apr 2011

See all articles by Karel Mertens

Karel Mertens

Federal Reserve Banks - Federal Reserve Bank of Dallas

Morten O. Ravn

University College London

Date Written: April 2011

Abstract

We study liquidity trap dynamics driven by nonfundamental shifts in expectations in a model with nominal rigidities, housing, credit frictions and a Taylor rule. Highly leveraged borrowing through nominal debt backed by real estate collateral greatly magnifies the decline in output and house prices during a liquidity trap recession. The amplification mechanism is much smaller when there is no feedback from house prices to the borrowing constraint, when debt is real rather nominal, and when leverage is small. We argue that the liquidity trap dynamics share some important features with the recent US recession and that high levels of leverage may have made the economy sensitive to expectations induced liquidity traps.

Keywords: collateral constraint, expectations, housing, leverage, liquidity trap

JEL Classification: E2, E3, E5

Suggested Citation

Mertens, Karel and Ravn, Morten O., Credit Channels in a Liquidity Trap (April 2011). CEPR Discussion Paper No. DP8322, Available at SSRN: https://ssrn.com/abstract=1810287

Karel Mertens (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Dallas ( email )

2200 North Pearl Street
PO Box 655906
Dallas, TX 75265-5906
United States

Morten O. Ravn

University College London ( email )

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