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.|
|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.