DP9636 Safety Traps
Author(s): | Kenza Benhima, Baptiste Massenot |
Publication Date: | September 2013 |
Keyword(s): | Business cycles, Japan's lost decade, Risk aversion |
JEL(s): | E22, E32 |
Programme Areas: | International Macroeconomics |
Link to this Page: | cepr.org/active/publications/discussion_papers/dp.php?dpno=9636 |
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.