Discussion paper

DP8890 On the optimal supply of liquidity with borrowing constraints

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.

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Citation

Lippi, F and N Trachter (2012), ‘DP8890 On the optimal supply of liquidity with borrowing constraints‘, CEPR Discussion Paper No. 8890. CEPR Press, Paris & London. https://cepr.org/publications/dp8890