Working Paper: NBER ID: w29238
Authors: Rohan Kekre; Moritz Lenel
Abstract: We study a business cycle model of the international monetary system featuring a time-varying demand for safe dollar bonds, greater risk-bearing capacity in the U.S. than the rest of the world, and nominal rigidities. A flight to safety generates a dollar appreciation and decline in global output. Dollar bonds thus command a negative risk premium and the U.S. holds a levered portfolio of capital financed in dollars. We quantify the effects of safety shocks and heterogeneity in risk-bearing capacity for global macroeconomic volatility; U.S. external adjustment; and policy transmission, as of dollar swap lines.
Keywords: safety shocks; dollar bonds; risk-bearing capacity; global output; US external adjustment
JEL Codes: E44; F44; G15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| safety shocks (J28) | stronger dollar (F31) |
| safety shocks (J28) | decline in global output (F69) |
| increased demand for safe dollar bonds (F31) | macroeconomic volatility (E39) |
| positive safety shock (J28) | rise in asset returns relative to safe dollar bonds (G12) |
| rise in asset returns relative to safe dollar bonds (G12) | deflation (E31) |
| deflation (E31) | decline in real interest rates (E43) |
| decline in real interest rates (E43) | decreased global consumption (F62) |
| decline in real interest rates (E43) | decreased investment (E22) |
| safety shocks (J28) | negative risk premium on dollar bonds (F31) |
| US's greater risk-bearing capacity (H12) | absorb shocks better than other economies (F69) |
| safety shocks (J28) | account for more than 25% of output volatility in the US (E39) |
| creation of safe dollar liquidity through dollar swap lines (F33) | stimulative effect on global economy (F69) |
| creation of safe dollar liquidity through dollar swap lines (F33) | meaningful stabilization role during financial crises (E63) |