Source 5 - Caballero, Farhi and
Gourinchas (2017) Journal of Economic
Perspectives.
Full reference (APA): Caballero, R. J., Farhi, E., & Gourinchas, P.-O. (2017).
The Safe Assets Shortage Conundrum.
Journal of Economic Perspectives, 31(3), 29 46.
[Link]
Article page: [Link]
Free PDF: [Link]
The Conflict of the Unsafe Assets Shortage.
What this is :
An article, peer reviewed, that describes what safe assets are (claims that
maintain their value during bad times), why there is a shortage of them in
the world, and what that implies regarding the interest rates, the financial
stability, and policy. It is a resource to consult on the shortage of safe
assets.
Type & credibility:
Top policy journal (JEP); authored by three of the foremost
macroeconomists. Very commonly referred to as a research finding and in
policy discussions.
Where to find it:
In the AEA webpage: the article page and a free PDF.
Central question:
What are safe assets? Why are they scarce? What is the impact of that
scarcity on rates, crises and the overall economy? What can policy do?
What they did (method)
Explain the concept of safe assets and its application as collateral and
liquidity in the field of modern finance.
Evidence demonstrating this Show Facts: The world needs safety (aging,
regulation, emerging-market reserves), and the only way to obtain it is
through a few plausible sovereigns (e.g., U.S. Treasuries).
Elaborate on why the safety of private safe assets (e.g. complex
securitizations) can be impaired during a crisis.
Talk about policy alternatives to alleviate the shortage: believable
management of the public debt, institutional reform, and macro policies
that can facilitate the efficient provision of safe assets without fuelling
risks.
Summary:
This paper makes the case that certain assets remain "safe" only because
people continue to believe in them even when times get tough-think U.S.
government bonds. The problem is that there aren't enough of these safe
assets globally. Investors chase safety, but only a handful of strong
governments can supply it, and many so-called "AAA" private products
collapsed during the 2008 crisis. When safe assets are in short supply,
their prices rise and yields plummet, leaving economies with weak
spending and investment.
Safe public debt does a great deal of quiet, essential work as well: banks
and markets depend on it as rock-solid collateral to move money around,
which reduces borrowing costs for all. Private impersonators of safety are
apt to be fragile; they appear to be solid when times are good and no one
is trying to get out, but they tend to crumble under stress. The authors
therefore recommend increasing the supply of really safe public assets
cautiously where credibility allows, indeed even exploring shared "euro-
safe" options, while also making private "safe" assets more resilient
through explicit safeguards.
Bottom line: it is useful public debt, anchoring the financial system and
supporting productive borrowing; the challenge is to provide enough of it
without jeopardizing the government's credibility.
Key results:
Safe assets are lacking throughout the world. When the demand is high
and supply is low, the safety price will increase and the safe interest rate
will decrease.
The especial role is played by high-credibility public debt: this is the
collateral which keeps markets and banks operating (repo, payments,
liquidity).
When the supply of safe assets is not sufficiently high, the economies may
fall into a safety trap (very low interest rates, low demand).
Privately constructed safe assets are weak; most of them lose their safe
label in times of stress.
Policy implication: a plausible stock of state safe assets can stabilize
finance, reduce the cost of finance and facilitate the investment of the
private sector.
Short quote:
When the desire of the safety surpasses the trustworthy supply, the safe
rates decrease and the financial system becomes stretched; believable
public safe assets can assist in anchoring funding and liquidity.
The importance of this to your project:
This provides a systemic explanation of why a little bit of public debt is
helpful. Credible sovereign bonds are the secure backbone of the financial
system even in the pre-construction phase of anything that a government
is building: they are the mortgage of the banks; the cash of markets.
Borrowing costs are reduced with sufficient safe assets, and productive,
private debt (firms, households) is easier and safer. Well-run public debt
can make beneficial borrowing through the entire economy possible.
(Optional) limits to note:
It is an idea + data, not one causal guess at the amount of debt each
nation ought to issue.
The credibility of a country (inflation, fiscal stance, institutions, currency
regime) determines whether the debt in the country is safe or not.