Working Paper: NBER ID: w29626
Authors: Markus K. Brunnermeier; Sebastian A. Merkel; Yuliy Sannikov
Abstract: The price of a safe asset reflects not only the expected discounted future cash flows but also future service flows, since retrading allows partial insurance of idiosyncratic risk in an incomplete markets setting. This lowers the issuers' interest burden and allows the government to run a permanent (primary) deficit without ever paying back its debt. As idiosyncratic risk rises during recessions, so does the value of the service flows bestowing the safe asset with a negative beta. This resolves government debt valuation puzzles. Nevertheless, the government faces a “Debt Laffer Curve”. The paper also has important implications for fiscal debt sustainability.
Keywords: No keywords provided
JEL Codes: E44; G11; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| service flows (L89) | valuation of government debt (H63) |
| idiosyncratic risk rises (G19) | value of service flows (D46) |
| government policy (F68) | market perceptions of safety (D18) |
| increased issuance of government bonds (H63) | diminishing returns on tax revenue (H29) |
| retrade of government bonds (E43) | attractiveness as a hedge against risk (G11) |
| idiosyncratic risks (D81) | demand for government bonds (E43) |
| idiosyncratic risks (D81) | interest rate (E43) |
| economic conditions (E66) | valuation of government debt (H63) |