Showing papers by "Guido Lorenzoni published in 2010"
TL;DR: In this paper, the authors study how information spillovers impact the incentives that agents face when making their real economic decisions and find that the sensitivity of equilibrium outcomes to noise and to higher-order uncertainty is amplified, exacerbating the disconnect from fundamentals.
Abstract: The arrival of new, unfamiliar, investment opportunities is often associated with "exuberant" movements in asset prices and real economic activity. During these episodes of high uncertainty, financial markets look at the real sector for signals about the profitability of the new investment opportunities, and vice versa. In this paper, we study how such information spillovers impact the incentives that agents face when making their real economic decisions. On the positive front, we find that the sensitivity of equilibrium outcomes to noise and to higher-order uncertainty is amplified, exacerbating the disconnect from fundamentals. On the normative front, we find that these effects are symptoms of constrained inefficiency; we then identify policies that can improve welfare without requiring the government to have any informational advantage vis-a-vis the market. At the heart of these results is a distortion that induces a conventional neoclassical economy to behave as a Keynesian "beauty contest" and to exhibit fluctuations that may look like "irrational exuberance" to an outside observer.
71 citations
TL;DR: In this paper, the authors study how information spillovers impact the incentives that agents face when making their real economic decisions and find that the sensitivity of equilibrium outcomes to noise and to higher-order uncertainty is amplified, exacerbating the disconnect from fundamentals.
Abstract: The arrival of new, unfamiliar, investment opportunities is often associated with "exuberant" movements in asset prices and real economic activity. During these episodes of high uncertainty, financial markets look at the real sector for signals about the profitability of the new investment opportunities, and vice versa. In this paper, we study how such information spillovers impact the incentives that agents face when making their real economic decisions. On the positive front, we find that the sensitivity of equilibrium outcomes to noise and to higher-order uncertainty is amplified, exacerbating the disconnect from fundamentals. On the normative front, we find that these effects are symptoms of constrained inefficiency; we then identify policies that can improve welfare without requiring the government to have any informational advantage vis-a-vis the market. At the heart of these results is a distortion that induces a conventional neoclassical economy to behave as a Keynesian "beauty contest" and to exhibit fluctuations that may look like "irrational exuberance" to an outside observer.
5 citations
Posted Content•
TL;DR: The authors argue that shocks that affect the private agents' ability to borrow are precisely the type of shocks that can push the economy in a liquidity trap, and they show that when preferences display prudence, these shocks tend to make consumers more cautious, leading both to lower levels of spending and to larger liquidity premia.
Abstract: In this paper, we argue that shocks that affect the private agents' ability to borrow are precisely the type of shocks that can push the economy in a liquidity trap. We show that, when preferences display prudence, these shocks tend to make consumers more cautious, leading both to lower levels of spending and to larger liquidity premia. Larger liquidity premia mean that the required real interest rate on highly liquid assets, like treasuries, tends to drop and can, possibly, go negative. This is what triggers a liquidity trap.
2 citations
Posted Content•
TL;DR: In this paper, the role of financial firms in facilitating the flow of funds from borrowers to lenders is explored, where they act as informed traders in the market for the securities issued by the borrowers.
Abstract: This paper explores the role of the financial sector in facilitating the flow of funds from borrowers to lenders. Unlike in traditional models of banking, the role of financial firms in our model is not to raise funds from lenders (depositors) and use them to make loans to borrowers. Rather their role is to act as informed traders in the market for the securities issued by the borrowers. By collecting information and taking large positions when prices deviate from fundamentals, financial firms help the price to be more stable and more informative, thus allowing uninformed lenders to allocate their funds more efficiently. We then explore how the balance sheets of the financial firms matters for the smooth functioning of this form of intermediation and discuss crises.