Working Paper: NBER ID: w22044
Authors: Ricardo J. Caballero; Emmanuel Farhi; Pierre-Olivier Gourinchas
Abstract: We explore the consequences of safe asset scarcity on aggregate demand in a stylized IS-LM/Mundell Fleming environment. Acute safe asset scarcity forces the economy into a “safety trap” recession. In the open economy, safe asset scarcity spreads from one country to the other via capital flows, equalizing interest rates. Acute global safe asset scarcity forces the economy into a global safety trap. The exchange rate becomes indeterminate but plays a crucial role in both the distribution and the magnitude of output adjustment across countries. Policies that increase the net supply of safe assets somewhere are output enhancing everywhere.
Keywords: safe assets; aggregate demand; IS-LM model; Mundell-Fleming; safety trap
JEL Codes: E0; F3; F4; G1
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| acute safe asset scarcity (E44) | output (C67) |
| acute safe asset scarcity (E44) | risk premium (G19) |
| supply of safe assets (E41) | output (C67) |
| supply of safe assets (E41) | risk premium (G19) |
| fiscal stimulus financed by safe debt (E62) | global output (F01) |
| taxes (H29) | demand (R22) |
| taxes (H29) | risk premiums (G19) |