Reserve Asset Competition and the Global Fiscal Cycle

Abstract

Governments tend to increase their borrowing at the same time, giving rise to a global fiscal cycle. This global fiscal cycle has a large component that is unexplained by global business cycle variables. We propose a novel explanation for the emergence of the common variation based on governments engaging in competition over the provision of reserve assets. Competition in the provision of safe assets gives rise to strategic complementarity in the issuance decision, even when the reserve assets are substitutes in partial equilibrium. We show our reserve-asset-competition channel gives rise to economically significant common variations in fiscal variables, beyond the common variations induced by correlated business cycles. In doing so, our model of reserve asset demand and supply also shines light on the sources of variations in the convenience yields and seigniorage revenues earned on government debt.

Keywords: Government Debt, Reserve Assets, Exorbitant Privilege