The Safety Trap – The Financial Market and Macroeconomic Consequences of the Scarcity of Safe Assets
Financial and Economic Review, Vol. 14. Issue 1. pp. 111-138.
28 Pages Posted: 30 Mar 2016
Date Written: March 30, 2015
Despite near-zero interest rates set by large central banks and other steps towards monetary easing in recent years, the economic environment has been characterised by low inflation globally and deflationary fears in some regions, while real economic activity has remained moderate. Although symptoms of this phenomenon are similar to that of the liquidity trap, important differences may be identified, which suggests that other factors may be important as well. One of the new approaches to appear in the literature identifies the structural excess demand of safe assets as a background factor that was aggravated by cyclical effects in the crisis. The mechanism of the so-called safety trap is similar to that of the liquidity trap, but it can be observed among safe assets; therefore, it can be considered a special type of liquidity trap. Financial market tensions trigger an economic downturn and a deflationary spiral in both cases, but different types of monetary policy responses may be effective. While forward guidance may be effective in the case of a liquidity trap, certain quantitative easing policies may provide a solution in the case of a safety trap
Keywords: financial markets, risk-free assets, liquidity trap, monetary policy
JEL Classification: G01, G15, E44, E52
Suggested Citation: Suggested Citation