Credit Crises, Precautionary Savings, and the Liquidity Trap

Veronica Guerrieri
Guido Lorenzoni
Publication Type: 
Working Papers
Publication Year: 
2011

We study the effects of a credit crunch on consumer spending in a heterogeneous-agent incomplete-market model. After an unexpected permanent tightening in consumers’ borrowing capacity, some consumers are forced to deleverage and others increase their precautionary savings. This depresses interest rates, especially in the short run, and generates an output drop, even with flexible prices. The output drop is larger with nominal rigidities, if the zero lower bound prevents the interest rate from adjusting downwards. Adding durable goods to the model, households take larger debt positions and the output response may be larger.

This paper was presented at the Flow of Funds Accounts and Savings Workshop in April of 2012. The corresponding presentation and discussion are also available.

Region: 
Global
Topic: 
Flow of Funds
Topic: 
Credit
Topic: 
Savings
Topic: 
Economic Modeling