Liquidity Traps and Monetary Policy: Managing a Credit Crunch
February 2017 | Federal Reserve Bank of Minneapolis Staff Report 540
We study a model with heterogeneous producers that face collateral and cash-in-advance constraints. A tightening of the collateral constraint results in a credit-crunch-generated recession that reproduces several features of the ﬁnancial crisis that unraveled in 2007 in the United States. The model can be used to study the effects of the credit-crunch on the main macroeconomic variables and the impact of alternative policies. The policy implications regarding forward guidance are in contrast with the prevalent view in most central banks, based on the New Keynesian explanation of the liquidity trap.