 Absence of safe assets and fiscal crisisMasaya Sakuragawa and Yukie Sakuragawa Journal of the Japanese and International Economies, 2016, vol. 40, issue C, 59-76 Abstract: This paper develops a fiscal crisis model that explains a mechanism under which low interest rates can coexist with Japan's large outstanding debt. The key idea is that when there is a strong home bias in the asset portfolio of domestic bondholders, these investors turn out to have no access to any assets that hedge fiscal risk. This explains why domestic investors do not request a risk premium on government bonds. In this environment, the interest rate and the default probability are low, and the government can sustain its large debt even under adverse fiscal conditions. As the interest rate does not rise fully to reflect the risk premium, the low interest rate is not always a signal of sound fiscal conditions. The welfare implications of financial market reform are mixed. This reform can improve welfare so long as the government can sustain the debt, but at the same time, it makes it difficult to sustain the debt because the interest rate rises. Quantitative easing is effective in lowering the risk premium. Keywords: Fiscal crisis; Safe asset; Risk premium; Sustainability (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:eee:jjieco:v:40:y:2016:i:c:p:59-76 DOI: 10.1016/j.jjie.2016.03.006 Access Statistics for this article Journal of the Japanese and International Economies is currently edited by Takeo Hoshi More articles in Journal of the Japanese and International Economies from Elsevier |
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