International Journal of Central Banking (prepared for the 4th Financial Stability Conference)
12 Pages Posted: 1 Feb 2013
Date Written: January 31, 2013
Treasury bonds provide money-like services, while other bonds do not. These money-like services, which include safety and liquidity, are valued more during financial crises, reducing the substitutability of actual Treasuries and synthetic Treasuries — other types of bonds that yield the same cash flows. Large equilibrium yield spreads between actual and synthetic Treasuries result. During the recent U.S. financial crisis, large-scale asset purchases by the Fed may have widened these spreads. To avoid policy-induced instability in bond markets, monetary authorities may have to stand ready to exchange actual and synthetic Treasuries at fixed exchange rates. These recent episodes of instability in the bond markets are analogous to the occasional large depreciations of small coins experienced by economies that used commodity money during periods of perceived shortages of small coins. This source of monetary instability was eventually eliminated by fixing the exchange rate of different coins (Sargent and Velde 2002).
Keywords: central banking, quantitative easing, fixed income
JEL Classification: E58, E43, E44
Suggested Citation: Suggested Citation
Lustig, Hanno N., A European History Lesson for Today’s Central Bankers (January 31, 2013). International Journal of Central Banking (prepared for the 4th Financial Stability Conference). Available at SSRN: https://ssrn.com/abstract=2209872