Uncovering the Effects of the Zero Lower Bound with an Endogenous Financial Wedge

AEJ Macro Forthcoming

132 Pages Posted: 12 Feb 2020 Last revised: 2 Oct 2021

See all articles by Dan Cao

Dan Cao

Georgetown University - Department of Economics

Wenlan Luo

Tsinghua University - School of Economics & Management

Guangyu Nie

Shanghai University of Finance and Economics

Date Written: February 15, 2019

Abstract

We study the effects of the Zero Lower Bound (ZLB) on the severity of financial crises using an incomplete markets New Keynesian model with two occasionally binding constraints: a ZLB on the nominal interest rate and a borrowing constraint tied to an asset price. The model's financial wedge corresponds to an endogenous multiplier on the borrowing constraint. Binding ZLB exacerbates financial crises through its interaction with the asset fire-sale vicious cycle, driving up the financial wedge. Our results offer a novel reinterpretation of the negligible effect of the ZLB in representative agent New Keynesian models with exogenous wedges.

Keywords: Zero Lower Bound, Fisherian Asset Price Deflation, Global Solution

JEL Classification: C60, E20, E30, E40, E50, G11

Suggested Citation

Cao, Dan and Luo, Wenlan and Nie, Guangyu, Uncovering the Effects of the Zero Lower Bound with an Endogenous Financial Wedge (February 15, 2019). AEJ Macro Forthcoming, Available at SSRN: https://ssrn.com/abstract=3531341 or http://dx.doi.org/10.2139/ssrn.3531341

Dan Cao (Contact Author)

Georgetown University - Department of Economics ( email )

Washington, DC 20057
United States

Wenlan Luo

Tsinghua University - School of Economics & Management ( email )

Beijing, 100084
China

Guangyu Nie

Shanghai University of Finance and Economics ( email )

777 Guoding Road
Shanghai, Shanghai 200433
China

HOME PAGE: http://www.nieguangyu.wixsite.com/econ

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