The Side Effects of Safe Asset Creation

55 Pages Posted: 6 Mar 2018 Last revised: 20 Aug 2018

See all articles by Sushant Acharya

Sushant Acharya

Federal Reserve Banks - Federal Reserve Bank of New York

Keshav Dogra

Federal Reserve Banks - Federal Reserve Bank of New York

Multiple version iconThere are 2 versions of this paper

Date Written: March 1, 2018

Abstract

We present an incomplete markets model to understand the costs and benefits of increasing government debt in a low interest rate environment. Higher risk increases the demand for safe assets, lowering the natural rate of interest below zero, constraining monetary policy at the zero lower bound, and raising unemployment. Higher government debt satiates the demand for safe assets, raising the natural rate and restoring full employment. While this permanently lowers investment, a policymaker committed to low inflation has no alternative. Higher inflation targets, instead, permit both full employment and high investment, but allow for harmful bubbles. Aggressive fiscal policy can prevent bubbles.

Keywords: safe assets, negative natural rate, crowding out, risk premium, liquidity traps, bubbles

JEL Classification: E3, E4, E5, G1, H6

Suggested Citation

Acharya, Sushant and Dogra, Keshav, The Side Effects of Safe Asset Creation (March 1, 2018). FRB of New York Staff Report No. 842, Available at SSRN: https://ssrn.com/abstract=3134704 or http://dx.doi.org/10.2139/ssrn.3134704

Sushant Acharya (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States

Keshav Dogra

Federal Reserve Banks - Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States

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