On the Optimal Supply of Liquidity with Borrowing Constraints

58 Pages Posted: 4 Apr 2012

See all articles by Francesco Lippi

Francesco Lippi

University of Sassari

Nicholas Trachter

Federal Reserve Banks - Federal Reserve Bank of Richmond

Date Written: March 2012

Abstract

We characterize policies for the supply of liquidity in an economy where agents have a precautionary savings motive due to random production opportunities and the presence of borrowing constraints. We show that a socially efficient provision of liquidity involves a trade-off between insurance and production incentives. Two scenarios are studied: if no aggregate information is available to the policy maker, constant flat expansions are socially beneficial if unproductive spells are sufficiently long. If some aggregate information is available, a socially beneficial state-dependent policy prescribes expanding the supply of liquidity in recessions and contracting it in expansions.

Keywords: Friedman rule, Heterogenous agents, Incomplete markets, Liquidity, Precautionary savings, State dependent policy.

JEL Classification: E5

Suggested Citation

Lippi, Francesco and Trachter, Nicholas, On the Optimal Supply of Liquidity with Borrowing Constraints (March 2012). CEPR Discussion Paper No. DP8890. Available at SSRN: https://ssrn.com/abstract=2034108

Francesco Lippi (Contact Author)

University of Sassari ( email )

Piazza Universita
Sassari, 07100
Italy

Nicholas Trachter

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

P.O. Box 27622
Richmond, VA 23261
United States

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