Federica Romei

We develop a model where labor market monopsony and income risk generate multiple equilibria for the equilibrium real interest rate, R∗. Firms’ debt issuance amplifies labor income risk, making household asset demand non-monotonic. One equilibrium features higher R∗ and lower risk; another, lower R∗, higher debt, and higher risk. Policy affects equilibrium selection: central bank asset purchases lower R∗, while government debt raises it. Empirical evidence supports our prediction that asset supply changes have differing effects on interest rates before and after the Global Financial Crisis.