The Side Effects of Safe Asset Creation

Sushant Acharya and Keshav Dogra

No 14440, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We present an incomplete markets model to understand the costs and benefits of increasing government debt when an increased demand for safety pushes the natural rate of interest below zero. A higher demand for safety widens spreads, causing the ZLB to bind and increasing unemployment. Higher government debt satiates the demand for safe assets, raising the natural rate, and restoring full employment. This entails permanently lower investment which reduces welfare, since our economy is dynamically efficient even when the natural rate is negative. Despite this, increasing debt is optimal if alternative instruments are unavailable. Alternative policies which permit negative real interest rates - higher inflation targets, negative nominal rates - achieve full employment without reducing investment.

Keywords: Safe assets; Negative natural rate; Crowding out; risk premium; Liquidity traps (search for similar items in EconPapers)
JEL-codes: E3 E4 E5 G1 H6 (search for similar items in EconPapers)
Date: 2020-02
New Economics Papers: this item is included in nep-cba, nep-dge and nep-mac
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Citations: View citations in EconPapers (2)

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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 (2018)
Working Paper: The Side Effects of Safe Asset Creation (2017)
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