Breaking the spell with credit-easing: Self-confirming credit crises in competitive search economies

Authors: Gaetano Gaballo and Ramon Marimon

Journal of Monetary Economics, Vol. 119, 1-20, April, 2021

In self-confirming crises lenders charge high interest rates wrongly believing that lower rates would generate losses. In a directed-search economy, misperceptions can persist because there is no equilibrium evidence that can confute it, preventing constrained-efficiency. A policy maker with the same beliefs as lenders will find it optimal to offer a contingent subsidy to induce lower market rates. As lenders price assets in response to this policy, new information may disprove misperceptions and restore efficiency. New micro-evidence suggests that the 2009 TALF intervention in the market of newly generated ABS was an example of the optimal policy in our model.