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The Side Effects of Safe Asset Creation

Author

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  • Keshav Dogra

    (Federal Reserve Bank of New York)

  • Sushant Acharya

    (Federal Reserve Bank of New York)

Abstract

We present a model with incomplete markets in order to understand the costs and benefits of increasing government debt in a low interest rate environment. Higher idiosyncratic risk increases the demand for safe assets and can even lower real interest rates below zero. A fiscal authority can issue more debt to meet this increased demand for safe assets and arrest the decline in real interest rates. While such a policy succeeds in keeping real rates above zero, it comes at a cost as higher real interest rates can lead to permanently lower investment. However, in an environment with nominal rigidities and a zero bound on nominal rates, policymakers may not have a choice. On the one hand, without creating additional safe assets, constrained monetary policy is powerless to combat higher unemployment. On the other hand, creating safe assets can make monetary policy potent again, allowing policymakers to lower unemployment, but such a policy only shifts the malaise elsewhere in the economy where it manifests itself as a permanent investment slump.

Suggested Citation

  • Keshav Dogra & Sushant Acharya, 2017. "The Side Effects of Safe Asset Creation," 2017 Meeting Papers 1453, Society for Economic Dynamics.
  • Handle: RePEc:red:sed017:1453
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    References listed on IDEAS

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    Cited by:

    1. Toan Phan & Andrew Hanson & Siddhartha Biswas, 2018. "Bubbly Recessions," 2018 Meeting Papers 440, Society for Economic Dynamics.
    2. Biswas, Siddhartha & Hanson, Andrew & Phan, Toan, 2018. "Bubbly Recessions," Working Paper 18-5, Federal Reserve Bank of Richmond.

    More about this item

    JEL classification:

    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • G1 - Financial Economics - - General Financial Markets
    • H6 - Public Economics - - National Budget, Deficit, and Debt

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