Abstract Using a monetary model with asset scarcity, we show that a liquidity trap caused by a persistent deleveraging shock increases real cash holdings and decreases investment and output in… Click to show full abstract
Abstract Using a monetary model with asset scarcity, we show that a liquidity trap caused by a persistent deleveraging shock increases real cash holdings and decreases investment and output in the medium term. This medium-term supply-side effect arises when firms face financial constraints. Policy implications differ from shorter-run analyses implied by nominal rigidities. Quantitative easing leads to a deeper liquidity trap. Exiting the trap by increasing expected inflation or applying negative interest rates does not solve the asset scarcity problem. A higher government debt helps exiting the liquidity trap and reduces asset scarcity, but may hurt investment in the medium run.
               
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