Working Paper: CEPR ID: DP18324
Authors: Enrique Mendoza; Vincenzo Quadrini
Abstract: The sharp, secular decline in the world real interest rate of the past thirty years suggests that the surge in global demand for financial assets outpaced the growth in their supply. We argue that this phenomenon was driven by: (i) faster growth in emerging markets, (ii) changes in the financial structure of both emerging and advanced economies, and (iii) changes in demand and supply of public debt issued by advanced economies. We then show that the low-interest-rate environment made the world economy more vulnerable to financial crises. These findings are the quantitative predictions of a two-region model in which privately-issued financial assets (i.e., inside money) provide productive services but can be defaulted on.
Keywords: Development
JEL Codes: F34; F62; G01
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| surge in global demand for financial assets (F65) | sharp decline in world real interest rates (E43) |
| low-interest-rate environment (E43) | increased vulnerability of the world economy to financial crises (F65) |
| structural changes in productivity, financial structure, and foreign reserves (O49) | increased demand for financial assets (E41) |
| increased demand for financial assets (E41) | sharp decline in world real interest rates (E43) |
| increase in public debt issued by advanced economies (H63) | mitigated decline in interest rates (E43) |
| structural changes in productivity, financial structure, and foreign reserves (O49) | observed trends in macroeconomic and financial volatility (E32) |