The Risks of Safe Assets

64 Pages Posted: 13 Nov 2020

See all articles by Yang Liu

Yang Liu

The University of Hong Kong - Faculty of Business and Economics

Lukas Schmid

University of Southern California - Marshall School of Business

Amir Yaron

University of Pennsylvania -- Wharton School of Business; National Bureau of Economic Research (NBER)

Date Written: September 25, 2020

Abstract

How much safety and liquidity can the US government provide? Should it accommodate demand for these attributes because high convenience yields in Treasuries lower its cost of borrowing? We evaluate a novel fiscal risk channel limiting the government's capacity to provide such services. Rising government debt lowers liquidity premia, but creates excess tax volatility through fiscal amplification, raising risk premia and credit spreads as well as firms' cost of capital thereby crowding out real activity. Our general equilibrium model suggests that this channel leads to significantly depressed growth prospects and rising Treasury yields. We use our model to quantitatively evaluate current proposals on unconventional stabilization policies and find that these effects are exacerbated in times of fiscal stress. Increasing safe asset supply can thus be risky, and have a significant fiscal cost.

Keywords: Government debt, safe assets, liquidity premium, uncertainty, growth, fiscal costs, risk premia, credit spreads, cost of capital, unconventional stabilization policies

Suggested Citation

Liu, Yang and Schmid, Lukas and Yaron, Amir, The Risks of Safe Assets (September 25, 2020). Available at SSRN: https://ssrn.com/abstract=3699618 or http://dx.doi.org/10.2139/ssrn.3699618

Yang Liu

The University of Hong Kong - Faculty of Business and Economics ( email )

Pokfulam Road
Hong Kong
China

Lukas Schmid (Contact Author)

University of Southern California - Marshall School of Business ( email )

701 Exposition Blvd, HOH 431
Los Angeles, CA California 90089-1424
United States

Amir Yaron

University of Pennsylvania -- Wharton School of Business ( email )

The Wharton School
3620 Locust Walk
Philadelphia, PA 19104
United States
215-898-1241 (Phone)
215-898-6200 (Fax)

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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