The Side Effects of Safe Asset Creation. Issue 2 (29th September 2021)

• Record Type: Journal Article
• Authors: Acharya, Sushant; Dogra, Keshav
• Is Part Of: Journal of the European Economic Association. Volume 20:Issue 2(2022)
• Page Start: 581
• Page End: 625
• Publication Date: 2021-09-29
• Subjects: Economics -- Periodicals; Économie politique -- Périodiques; Science économique; Périodique électronique (Descripteur de forme); Ressource Internet (Descripteur de forme); 330
• DOI: 10.1093/jeea/jvab029
• Languages: English
• ISSNs: 1542-4766

Abstract

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 safe assets causes the zero lower bound (ZLB) to bind, increasing unemployment. Higher government debt satiates the demand for safe assets, raising the natural rate, and restoring full employment. However, 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 until the ZLB no longer binds raises welfare when alternative instruments are unavailable. Higher inflation targets instead allow for negative real interest rates and achieve full employment without reducing investment.