Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/96008 
Authors: 
Year of Publication: 
2011
Series/Report no.: 
Working Paper No. 2012-07
Publisher: 
Bar-Ilan University, Department of Economics, Ramat-Gan
Abstract: 
This paper explains the emergence of liquidity traps in the aftermath of large-scale financial crises, as happened in the US 1930s, Japan 1990s and recently in the US and Europe. The paper introduces a new balance sheet channel that links equity capital to the risk-free interest rate. When equity capital falls, bankruptcy risks rise. Firms become more vulnerable to external shocks, which makes financial disasters more likely to happen. Consequently, demand for safe assets increases, and the interest rate falls to the lower bound. Simulations show that the interest rate may stay at the lower bound for a long time.
Subjects: 
liquidity trap
financial crisis
rare disasters
equity capital
leverage
bankruptcy risk
JEL: 
E32
E43
E44
E52
G12
G32
Document Type: 
Working Paper

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