The Side Effects of Safe Asset Creation

Keshav Dogra and Sushant Acharya

No 1453, 2017 Meeting Papers from Society for Economic Dynamics

Abstract: We present a model with incomplete markets in order to understand the costs and benefits of increasing government debt in a low interest rate environment. Higher idiosyncratic risk increases the demand for safe assets and can even lower real interest rates below zero. A fiscal authority can issue more debt to meet this increased demand for safe assets and arrest the decline in real interest rates. While such a policy succeeds in keeping real rates above zero, it comes at a cost as higher real interest rates can lead to permanently lower investment. However, in an environment with nominal rigidities and a zero bound on nominal rates, policymakers may not have a choice. On the one hand, without creating additional safe assets, constrained monetary policy is powerless to combat higher unemployment. On the other hand, creating safe assets can make monetary policy potent again, allowing policymakers to lower unemployment, but such a policy only shifts the malaise elsewhere in the economy where it manifests itself as a permanent investment slump.

Date: 2017
New Economics Papers: this item is included in nep-dge and nep-mac
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Related works:
Journal Article: The Side Effects of Safe Asset Creation (2022)
Working Paper: The Side Effects of Safe Asset Creation (2021)
Working Paper: The Side Effects of Safe Asset Creation (2020)
Working Paper: The side effects of safe asset creation (2018)
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed017:1453

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