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

Recognition Program

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.

This paper is acknowledged by the Barcelona School of Economics Recognition Program