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Title: Safety Traps

Author(s): Kenza Benhima and Baptiste Massenot

Publication Date: September 2013

Keyword(s): Business cycles, Japan's lost decade and Risk aversion

Programme Area(s): International Macroeconomics

Abstract: Fear of risk provides a rationale for protracted economic downturns. We develop a real business cycle model where investors with decreasing relative risk aversion choose between a risky and a safe technology that exhibit decreasing returns. Because of a feedback effect from the interest rate to risk aversion, two equilibria can emerge: a standard equilibrium and a ``safe'' one in which investors invest in safer assets. We refer to the dynamics of this second equilibrium as a safety trap because it is self-reinforcing as investors accumulate more wealth and show it to be consistent with Japan's lost decade.

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Bibliographic Reference

Benhima, K and Massenot, B. 2013. 'Safety Traps'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=9636