The full column appears here:
https://www.ft.com/content/b98078c0-6acc-43e6-929b-13883c211288
Demand for safe assets has far out-stripped supply since 2009 but the latest crisis may help redress the balance.
One of the long-term consequences of the 2008 financial
crisis was a lack of safe assets that could be used by institutions to store
their wealth, meet regulatory requirements and provide collateral to borrow
additional funds. This problem has been identified as an important reason for
low capital investment and the slow growth rate in the global economy in the
past decade. It was also a prime cause of the European sovereign debt crisis,
which peaked in 2012.
A silver lining from the Covid-19 shock is that the policy
response may actually alleviate the safe-asset shortage, according to new research by Fulcrum economists (see table). That’s because it will leave a legacy
of much higher government debt in the most advanced economies, including the
US, which is the main global source of these assets.
Economists including Ricardo Caballero
and Emmanuel Farhi have established that in some models a shortage of
safe asset supply can result in a “safety trap” that affects the global
economy. This is a close cousin of the “liquidity trap” that appears in many
New Keynesian models. Because interest rates cannot fall enough to balance the
supply and demand for safe assets, national income and wealth shrink to
eliminate the excess demand for them.
The Covid-19 crisis will help because government debt in the
US and other advanced economies is surging. Although central bank and private
sector demand for safe assets may offset some of this extra supply, the overall
effect may be to reduce the safe asset shortage for a while as the global
economy recovers.
