NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Credit Crises, Precautionary Savings, and the Liquidity Trap

Veronica Guerrieri, Guido Lorenzoni

NBER Working Paper No. 17583
Issued in November 2011
NBER Program(s):   EFG   ME

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.

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Document Object Identifier (DOI): 10.3386/w17583

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