Working Paper: NBER ID: w18732
Authors: Gary B. Gorton; Guillermo Ordoñez
Abstract: Safe assets are demanded to smooth consumption across states (both intertemporally and in cross-section). Some of these assets are supplied publicly (government bonds) and some are created and supplied privately (such as mortgagebacked securities and asset-backed securities). Private assets are created endogenously when the supply of government bonds is low. Private assets are used as collateral and come in heterogeneous quality. Financial fragility is the probability that a large amount of private assets are examined, some are found to be of low quality and then some firms cannot get loans. We characterize the government’s optimal supply of government bonds when considering their effects on the creation of private assets and on economy-wide fragility. We show that monetary and macroprudential policies cannot be run in isolation. When there are too many private assets the government should operate a Bond Exchange Facility that exchanges private assets for public safe assets.
Keywords: safe assets; government bonds; private assets; financial stability; monetary policy; macroprudential policy
JEL Codes: E0; E02; E2; E3; E32; E4; E41; G01; G12; G2
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Low government bond supply (H74) | Increased private asset creation (D14) |
| Increased private asset creation (D14) | Increased financial fragility (F65) |
| Information about private asset quality revealed (D82) | Trigger financial crises (G01) |
| Government bond supply (H63) | Trade-off in consumption smoothing (D15) |
| Bond exchange facility (F33) | Mitigate financial fragility (E44) |