Working Paper: CEPR ID: DP10717
Authors: Arvind Krishnamurthy; Annette Vissing-Jorgensen
Abstract: We present a theory in which the key driver of short-term debt issued by the financial sector is the portfolio demand for safe and liquid assets by the non-financial sector. This demand drives a premium on safe and liquid assets that the financial sector exploits by owning risky and illiquid assets and writing safe and liquid claims against those. The central prediction of the theory is that safe and liquid government debt should crowd out financial sector lending financed by short-term debt. We verify this prediction in U.S. data from 1875-2014. We take a series of approaches to rule out ?standard" crowding out via real interest rates and to address potential endogeneity concerns.
Keywords: banking; financial stability; monetary economics; treasury supply
JEL Codes: E4; G12; G2
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Increase in treasury supply (H63) | Decrease in financial sector lending (G21) |
| Increase in treasury supply (H63) | Reduction in yield spreads between risky loans and safe assets (E43) |
| Reduction in yield spreads between risky loans and safe assets (E43) | Decrease in financial sector lending (G21) |