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Nicolas Caramp, Sanjay R Singh, Bond Premium Cyclicality and Liquidity Traps, The Review of Economic Studies, Volume 90, Issue 6, November 2023, Pages 2822–2879, https://doi.org/10.1093/restud/rdad003
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Abstract
Safe asset shortages can expose an economy to liquidity traps. The nature of these traps is determined by the cyclicality of the bond premium. A counter-cyclical bond premium opens the possibility of expectations-driven liquidity traps in which small issuances of government debt crowd out private debt and reduce output. In contrast, when the bond premium is pro-cyclical and the economy is in a liquidity trap, government debt is expansionary. In the data, we find evidence of a counter-cyclical bond premium. Large interventions can prevent the emergence of self-fulfilling traps, but they require sufficient fiscal capacity. In a quantitative model calibrated to the Great Recession, a promise to increase the government debt-to-GDP ratio by