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A model of the safe asset mechanism (sam): Safety traps and economic policy. mimeo,
- MIT .
, 2013
"... Abstract The global economy has a chronic shortage of safe assets which lies behind many recent macroeconomic imbalances. This paper provides a simple model of the Safe Asset Mechanism (SAM), its recessionary safety traps, and its policy antidotes. Public debt plays a central role in SAM as long as ..."
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Cited by 17 (1 self)
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Abstract The global economy has a chronic shortage of safe assets which lies behind many recent macroeconomic imbalances. This paper provides a simple model of the Safe Asset Mechanism (SAM), its recessionary safety traps, and its policy antidotes. Public debt plays a central role in SAM as long as the government has spare fiscal capacity to back safe asset production. We show that Quantitative Easing type policies have positive effects on spreads and output. In contrast, Operation Twist type policies, where the duration of public debt held by the public is reduced, can be counterproductive. Monetary policy commitments work if they support future bad states of nature. All these policies depend on fiscal capacity. Once the latter runs out, short term cyclical policy becomes ineffective. In contrast, credible long run fiscal consolidation relaxes the fiscal capacity constraint and enhances the effectiveness of short term policy. An economy that is near its fiscal limits is susceptible to runs on its public debt and to destabilizing feedback loops.
The safe asset share
- American Economic Review
, 2013
"... Abstract: We document that the percentage of all U.S. assets that are "safe" has remained stable at about 33 percent since 1952. This stable ratio is a rare example of calm in a rapidly changing financial world. Over the same time period, the ratio of U.S. assets to GDP has increased by a ..."
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Abstract: We document that the percentage of all U.S. assets that are "safe" has remained stable at about 33 percent since 1952. This stable ratio is a rare example of calm in a rapidly changing financial world. Over the same time period, the ratio of U.S. assets to GDP has increased by a factor of 2.5, and the main supplier of safe financial debt has shifted from commercial banks to the "shadow banking system." We analyze this pattern of stylized facts and offer some tentative conclusions about the composition of the safe-asset share and its role within the overall economy.
Short-term Debt and Financial Crises: What we can learn from U.S. Treasury Supply ∗
, 2012
"... We present a theory in which the key driver of short-term debt issued by the financial sector is the portfoliodemandforsafeandliquidassetsbythenon-financial sector. Households ’ demand for safe andliquidassetsdrivesapremiumonsuchassetsthatthefinancial sector exploits by owning risky and illiquid ass ..."
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Cited by 12 (0 self)
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We present a theory in which the key driver of short-term debt issued by the financial sector is the portfoliodemandforsafeandliquidassetsbythenon-financial sector. Households ’ demand for safe andliquidassetsdrivesapremiumonsuchassetsthatthefinancial sector exploits by owning risky and illiquid assets and writing safe and liquid claims against these assets. The central prediction of the theory is that government debt should be a substitute for the net supply of privately issued short-term debt. We verify this prediction with data from 1914 to 2011 by showing the net supply of government debt, predominantly Treasuries, is strongly negatively correlated with the net supply of private short-term debt, defined to be the private supply of short-term safe and liquid debt, net of the financial sector’s holdings of Treasuries (and reserves and currency). A second set of predictions of the model concern the quantity of money (i.e. liquid bank liabilities such as checking accounts). The theory predicts that when government supply is large, banks should hold more of the supply and use it to back issuance of more liquid bank liabilities. We confirm this prediction as well. Moreover, we show that accounting for the impact of Treasury supply on bank money results in a stable estimate for money demand and can help resolve the “missing money ” puzzle of the post-1980 period. Finally, the theory predicts that the quantity of short-term debt issued by the financial sector should predict financial crises better than standard measures such as private credit/GDP. We also confirm this prediction.
The Safety Trap
, 2014
"... Recently, the global economy has experienced recurrent episodes of safe asset short-ages. In this paper we present a model that shows how such shortages can generate macroeconomic phenomena similar to those found in liquidity trap scenarios. Despite the similarities, there are also subtle but import ..."
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Cited by 5 (0 self)
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Recently, the global economy has experienced recurrent episodes of safe asset short-ages. In this paper we present a model that shows how such shortages can generate macroeconomic phenomena similar to those found in liquidity trap scenarios. Despite the similarities, there are also subtle but important differences which carry significant impacts on the relative effectiveness of economic policy and potential market solutions to the underlying problem. For example, while forward guidance policies are typically more effective than quantitative easing ones in the standard liquidity trap environment, the opposite holds in safety trap contexts. Also, while asset bubbles (market solutions) and public debt are both effective in liquidity traps, only the latter are in safety traps. Essentially, a safe asset shortage is a deficit of a particular form of wealth (safe wealth), which the government has comparative advantage in supplying. Forward guidance and financial bubbles, which increase risky wealth and stimulate the economy in liquidity traps, fail to do so in safety traps as they are dissipated through higher spreads.
The Impact of Treasury Supply on Financial Sector Lending and Stability. Working Paper
, 2015
"... We present a theory in which the key driver of short-term debt issued by the financial sector is the portfolio demand for safe and liquid assets by the non-financial sector. This demand drives a premium on safe and liquid assets that the financial sector exploits by owning risky and illiquid assets ..."
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Cited by 4 (1 self)
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We present a theory in which the key driver of short-term debt issued by the financial sector is the portfolio demand for safe and liquid assets by the non-financial sector. This demand drives a premium on safe and liquid assets that the financial sector exploits by owning risky and illiquid assets and writing safe and liquid claims against those. The central prediction of the theory is that safe and liquid government debt should crowd out financial sector lending financed by short-term debt. We verify this prediction in U.S. data from 1875-2014. We take a series of approaches to rule out “standard " crowding out via real
Money Creation and the Shadow Banking System,
, 2013
"... Abstract Many explanations for the rapid growth of the shadow banking system in the mid2000s focus on money demand. This paper asks whether the short-term liabilities of the shadow banking system behave like money. We …rst present a simple model where households demand money services, which are sup ..."
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Cited by 3 (2 self)
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Abstract Many explanations for the rapid growth of the shadow banking system in the mid2000s focus on money demand. This paper asks whether the short-term liabilities of the shadow banking system behave like money. We …rst present a simple model where households demand money services, which are supplied by three types of claims: deposits, Treasury bills, and asset-backed commercial paper (ABCP). The model provides predictions for the price and quantity dynamics of these claims, as well as the behavior of the banking system (in terms of issuance) and the monetary authority (in terms of open market operations). Consistent with the model, the empirical evidence suggests that the shadow banking system does respond to money demand. An extrapolation of our estimates would suggest that heightened money demand could explain up to approximately 1/2 of the growth of ABCP in the mid-2000s.
An Evaluation of Money Market Fund Reform Proposals *
, 2013
"... We analyze the leading reform proposals to address the structural vulnerabilities of money market mutual funds (MMFs). We assume that the main goal of MMF reform is safeguarding financial stability. In light of this goal, reforms should reduce the ex ante incentives for MMFs to take excessive risk a ..."
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Cited by 2 (0 self)
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We analyze the leading reform proposals to address the structural vulnerabilities of money market mutual funds (MMFs). We assume that the main goal of MMF reform is safeguarding financial stability. In light of this goal, reforms should reduce the ex ante incentives for MMFs to take excessive risk and increase the ex post resilience of MMFs to system-wide runs. Our analysis suggests that requiring MMFs to have subordinated capital buffers could generate significant financial stability benefits. Subordinated capital provides MMFs with loss absorption capacity, lowering the probability that a MMF suffers losses large enough to trigger a run, and reduces incentives to take excessive risks. We estimate that a capital buffer in the range of 3 to 4 % would significantly reduce the probability that ordinary MMF shareholders ever suffer losses. In exchange for having the safer investment product made possible by subordinated capital, the yield paid to ordinary MMFs shareholders would decline by only 0.05%. Other reform alternatives such as converting MMFs to a floating NAV would likely be less effective in protecting financial stability.
Overnight RRP Operations as a Monetary Policy Tool: Some Design Considerations
, 2015
"... This paper presents preliminary findings and is being distributed to economists and other interested readers solely to stimulate discussion and elicit comments. The views expressed in this paper are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New Y ..."
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Cited by 2 (1 self)
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This paper presents preliminary findings and is being distributed to economists and other interested readers solely to stimulate discussion and elicit comments. The views expressed in this paper are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors.
A model of monetary policy and risk premia.
, 2014
"... Abstract We present a dynamic heterogeneous-agent asset pricing model in which monetary policy affects the risk premium component of the cost of capital. Risk tolerant agents (banks) borrow from risk averse agents (depositors) and invest in risky assets subject to a reserve requirement. By varying ..."
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Cited by 1 (0 self)
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Abstract We present a dynamic heterogeneous-agent asset pricing model in which monetary policy affects the risk premium component of the cost of capital. Risk tolerant agents (banks) borrow from risk averse agents (depositors) and invest in risky assets subject to a reserve requirement. By varying the nominal interest rate, the central bank affects the spread banks pay for external funding (i.e., leverage), a link that we show has strong empirical support. Lower nominal rates result in increased leverage, lower risk premia and overall cost of capital, and higher volatility. The effects of policy shocks are amplified via bank balance sheet effects. We use the model to implement dynamic interventions such as a "Greenspan put" and forward guidance, and analyze their impact on asset prices and volatility. JEL: E52, E58, G12, G21
Private Money Creation with Safe Assets and Term Premia *
"... Abstract It has been documented that an increase in the demand for safe assets induces the private sector to create more money-like claims. Focusing on private repos backed by U.S. Treasury securities, I show that an increase in the demand for safe assets leads to a decreases in the issuance of Tre ..."
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Abstract It has been documented that an increase in the demand for safe assets induces the private sector to create more money-like claims. Focusing on private repos backed by U.S. Treasury securities, I show that an increase in the demand for safe assets leads to a decreases in the issuance of Treasury repos. The intuition is that Treasury securities already function as a safe asset, thus in terms of safe asset creation, private Treasury repos are neutral. In the model, Treasury repos are beneficial because they shift risk (i.e. term premia) from relatively risk averse households to a more risk tolerant financial sector, which issues repos to finance its portfolio. When the demand for safe assets increases, Treasury securities are reallocated to households, reducing the amount of Treasury repo issued by the financial sector. By contrast, Treasury repos created by the Federal Reserve's RRP program-a safe asset created by the public sector-increase with the demand for safe assets. I show the data supports the model's main predictions. *
