DP8890 On the optimal supply of liquidity with borrowing constraints
Author(s): | Francesco Lippi, Nicholas Trachter |
Publication Date: | March 2012 |
Keyword(s): | Friedman rule, Heterogenous agents, Incomplete markets, Liquidity, Precautionary savings, State dependent policy. |
JEL(s): | E5 |
Programme Areas: | International Macroeconomics |
Link to this Page: | cepr.org/active/publications/discussion_papers/dp.php?dpno=8890 |
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.