Davide Porcellacchia (DG Research, European Central Bank) and Kevin Sheedy (London School of Economics) introduce the notion of pessimism in a real business cycle model, which is a standard framework for business cycle analysis.
The possibility of waves of pessimism generates countercyclical demand from banks for liquid assets (e.g., bank reserves).
With the model, they study the macroeconomic effects of the government supplying liquid assets and find that a policy of accommodating banks’ demand is effective in stabilising the economy.
The ECB Research Bulletin features a selection of recent work on policy-relevant topics by ECB economists. Published on a monthly basis, the articles in the Research Bulletin are intended for a general audience. The views expressed in each article are those of the authors and do not necessarily represent the views of the European Central Bank and the Eurosystem.
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