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How Safe and Liquid Assets Impact Monetary and Financial Policy

Paper Session

Saturday, Jan. 7, 2017 1:00 PM – 3:00 PM

Sheraton Grand Chicago, Mississippi
Hosted By: Society for Economic Dynamics
  • Chair: Juliane Begenau, Harvard University

Payments, Credit and Asset Prices

Monika Piazzezi
,
Stanford University
Martin Schneider
,
Stanford University

Abstract

This paper studies a monetary economy with two layers of transactions. In enduser
transactions, households and institutional investors pay for goods and securities with payment
instruments provided by banks. Endusers’ payment instructions generate interbank
transactions that banks handle with reserves or interbank credit. The model links the
payments system and securities markets so that beliefs about asset payoffs matter for the
price level, and monetary policy matters for real asset values.

A Model of Safe Asset Determination

Zhiguo He
,
University of Chicago
Arvind Krishnamurthy
,
Stanford University
Konstantin Milbradt
,
Northwestern University

Abstract

What makes an asset a “safe asset”? We study a model where two countries each issue sovereign bonds to satisfy investors' safe asset demands. The countries differ in the float of their bonds and their resources/fundamentals available to rollover debts. A sovereign's debt is more likely to be safe if its fundamentals are strong relative to other possible safe assets, but not necessarily strong on an absolute basis. Debt float can enhance or detract from safety: If global demand for safe assets is high, a large float can enhance safety. The large float offers greater liquidity which increases demand for the large debt and thus reduces rollover risk. If demand for safe assets is low, then large debt size is a negative as rollover risk looms large. When global demand is high, countries may make fiscal/debt-structuring decisions to enhance their safe asset status. These actions have a tournament feature, and are self-defeating: countries may over-expand debt size to win the tournament. Coordination can generate benefits. The model sheds light on the effects of “Eurobonds” – i.e. a coordinated Euro-area-wide safe bond design. Eurobonds deliver welfare benefits only when they make up a sufficiently large fraction of countries' debts. Small steps towards Eurobonds may hurt countries and not deliver welfare benefits.

The "Reversal Interest Rate": The Effective Lower Bound on Monetary Policy

Markus K. Brunnermeier
,
Princeton University
Yann Koby
,
Princeton University

Abstract

TBA

Lessons from the Financial Flows of the Great Recession

Juliane Begenau
,
Harvard Business School
Saki Bigio
,
University of California-Los Angeles
Jeremy Majerovitz
,
Massachusetts Institute of Technology

Abstract

We investigate the financial flows recorded in the United States during 2007-2009. First, we study the empirical consistency of the fire-sale hypothesis, the idea that bank lending was crowded out by the absorption of shadow-bank assets. This hypothesis is inconsistent. Data suggests that banks mostly intermediated the purchase of shadow-bank assets by the Fed, but did not use their lending capacity. Second, we study the consistency of the net-worth shock hypothesis. Again, the data reveals an inconsistency: bank book-equity losses were offset by equity issuances. Market-value losses, which in turn, provide a more precise diagnosis of a bank's health, were catastrophic. Although market leverage increased dramatically for many banks, these banks delevered very slowly. Whereas before the crisis, a bank would have tried to liquidate assets to delever, post-crisis the same bank relied on costly equity issuances. We present a model with strategic leverage accounting that can reconciles these inconsistencies.
JEL Classifications
  • E4 - Money and Interest Rates