Working Paper: NBER ID: w30832
Authors: Enrique G. 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: Globalization; Financial Crises; World Economy; Interest Rates
JEL Codes: F34; F36; F62; F65
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| increase in global demand for financial assets (F65) | significant decline in the world real interest rate (E43) |
| low interest rate environment (E43) | increased vulnerability of the world economy to financial crises (F65) |
| changes in productivity, financial structure, and foreign reserves (O49) | increase in demand for financial assets (G19) |
| increase in demand for financial assets (G19) | decline in interest rates (E43) |
| decline in interest rates (E43) | increase in effective leverage ratio (G32) |
| increase in effective leverage ratio (G32) | amplification of financial and macroeconomic volatility (E44) |
| rise in public debt from advanced economies (H63) | mitigated decline in interest rates (E43) |