The Side Effects of Safe Asset Creation

58 Pages Posted: 3 Mar 2020

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: February 2020

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: Crowding out, liquidity traps, negative natural rate, Risk premium, safe assets

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

Suggested Citation

Acharya, Sushant and Dogra, Keshav, The Side Effects of Safe Asset Creation (February 2020). CEPR Discussion Paper No. DP14440, Available at SSRN: https://ssrn.com/abstract=3547373

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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