A Model of the Safe Asset Mechanism (SAM): Safety Traps and Economic Policy

Ricardo Caballero () and Emmanuel Farhi

Working Paper from Harvard University OpenScholar

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 eff ects 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 fi scal capacity. Once the latter runs out, short term cyclical policy becomes ineff ective. In contrast, credible long run fiscal consolidation relaxes the fi scal capacity constraint and enhances the e ffectiveness of short term policy. An economy that is near its scal limits is susceptible to runs on its public debt and to destabilizing feedback loops.

Date: 2013-01
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Working Paper: A Model of the Safe Asset Mechanism (SAM): Safety Traps and Economic Policy (2013)
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