policymakers demonstrate

438 Charles Brendon and Giancarlo Corsetti
to their balance sheets, and so will not cause them any difficulties with the maximum
leverage ratio. Gertler and Karadi (2011) consider a scenario in which
the net worth of financial intermediaries is negatively affected by an exogenous
reduction in the quality of the assets they hold, providing them with a need to
reduce leverage and restrict loans – an attempt to capture the main features of
the subprime crisis. They show that an aggressive policy of credit easing by
the central bank is capable of substantially reducing the depth of the associated
recession.
One advantage of this policy is that it is not impeded by the zero bound constraint.
The higher the price that the central bank pays to buy loans securitized
by private-sector banks, the lower the nominal interest rate faced by borrowers.
There is no economic reason why the interest rate for borrowers need not
turn negative. As discussed above, difficulties come when savers face a negative
rate, and instead switch to holding cash. The central bank may be losing money
on asset holdings that pay a negative nominal return, but this could simply be
understood as the price of more effective stabilization. Provided the central
bank is only willing to purchase securities backed by real investment projects,
the scope for arbitrage should be limited.
Yet Gertler and Karadi’s mechanism has received some criticism, since it
implicitly grants the central bank greater technological capacity to operate in
financial markets than the private sector. The essential point is the following:
why should leverage restrictions constrain the ability of private banks to
channel funding to borrowers, but not the central bank? 33 Ongoing work by
Gaballo and Marimon (2015) explores a channel through which credit easing
can have an effect without relying on asymmetries of this form – operating
instead through the impact of policy on information about investment conditions.
34 Their framework is one in which firms have a choice between risky
and safe investment projects. Because of limited liability, the relative benefits
of risky investment increase in the interest rate that banks charge firms. Intuitively,
when required repayments are high, it is better to gamble on a high
return than to obtain a near-zero profit margin for sure. But the interest rate that
banks charge firms to borrow is, in turn, increasing in the perceived riskiness
of the investment projects that the firms will embark upon.
Gaballo and Marimon (2015) show that this setting is consistent with the
existence of a ‘self-confirming’ equilibrium, in which investment is inefficiently
risky and output inefficiently low. Banks observe that the typical investment
projects undertaken in the economy are risky, and for this reason they only offer
high interest rates to borrowers. Borrowers respond to this by selecting riskier
projects. A central bank policy of credit easing can ‘break the spell’ by making
banks willing to offer (and sell on to the monetary authority) lower-cost loans,
which in turn incentivize investing firms to embark on safer projects. According
to this theory, the role of credit easing is to provide an informational benefit to