Corporate Demand for Safe Assets and Government Crowding-In

73 Pages Posted: 9 Dec 2018 Last revised: 14 Jan 2019

See all articles by R. Jay Kahn

R. Jay Kahn

University of Michigan, Stephen M. Ross School of Business

Date Written: January 13, 2019


This paper quantifies a channel through which government borrowing can increase corporate investment. I present and estimate a general equilibrium model where long-lived corporations make endogenous corporate financing and investment decisions. The government affects these decisions through its issuance of safe debt. In the model, firms use safe assets to retain their earnings and avoid future financing costs. When the corporate sector is limited in its ability to create safe assets by the pledgeability of their capital, safe assets are scarce: a liquidity premium emerges, and the return on safe assets falls below the return on the firm in equilibrium. When safe assets are scarce, low interest rates on safe assets mean firms rely more on costly financing, resulting in lower investment. In this setting, in contrast to the common crowding-out story, increasing government borrowing raises the return on safe assets, making safe assets more available to firms and allowing them to better retain earnings in order to invest in the future. This channel is quantitatively important: estimating the model from data on the panel of public firms using structural methods, I find that a 1% increase in government borrowing increases the return on safe assets by 60 basis points and increases aggregate investment by 13 basis points. I explore the equilibrium consequences of a variety of standard corporate financing frictions through the lens of my model and validate its mechanism empirically by turning to the long time series of corporate cash holding, government borrowing, and spreads of corporate bonds over government bonds.

Keywords: corporate cash holding, precautionary savings, liquidity

JEL Classification: G31, G32, E22, E44, H63

Suggested Citation

Kahn, R. Jay, Corporate Demand for Safe Assets and Government Crowding-In (January 13, 2019). Available at SSRN: or

R. Jay Kahn (Contact Author)

University of Michigan, Stephen M. Ross School of Business ( email )

Ann Arbor, MI
United States

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