Research Summary
The report presents a theoretical model exploring the creation of safe assets by private and public entities, and its impact on systemic risk and aggregate demand. It highlights the role of monetary, fiscal, and macroprudential policies in stabilizing aggregate demand and reducing systemic risk. The model also explores the potential for risk-driven stagnation traps when high systemic risk leads to low economic growth. The report further discusses the different macroeconomic consequences of private and public safe asset creation.
Key Takeaways
Safe Asset Creation and Systemic Risk
- Private vs Public Safe Assets: Private safe assets created by financial intermediaries generate systemic risk due to leverage, while public safe assets created by the government do not generate systemic risk.
- Systemic Risk and Aggregate Demand: The level of systemic risk affects the neutral rate of interest and has implications for households’ precautionary saving and aggregate demand. There is a two-way interaction between systemic risk and aggregate demand in the model.
- Role of Monetary and Fiscal Policies: Monetary and fiscal policies can stabilize aggregate demand and reduce systemic risk by adjusting the mix of private and public safe assets held by savers.
Impact of Systemic Risk on Economic Growth
- Risk-Driven Stagnation Traps: Risk-driven stagnation traps can occur when high systemic risk leads to low economic growth.
- Role of Macroprudential Policies: Macroprudential policies that reduce systemic risk can stimulate aggregate demand.
- Private and Public Safe Assets: The model considers the distinction between private and public safe assets and their different capacities to bear aggregate risk.
Macroeconomic Consequences of Safe Asset Creation
- Private Safe Asset Creation: Private safe asset creation by banks has different macroeconomic consequences than public safe asset creation by the government. Private safe asset creation generates systemic risk, while public safe asset creation does not.
- Impact on Households: The level of systemic risk is determined by the composition of safe assets held by households. Crises reduce household’s future labor income due to macroeconomic spillover, resulting in lower future wages.
- Role of Monetary Policy: Monetary policy stimulates aggregate demand directly and through a macroprudential channel that reduces systemic risk.
Policy Interventions and Systemic Risk
- Fiscal Policy: Fiscal policy can stabilize aggregate demand and reduce systemic risk by altering the mix of private and public safe assets held by savers.
- Quantitative Easing: Quantitative easing can stimulate aggregate demand through macroprudential effects by shifting the composition of safe assets held by households toward public safe assets.
- Government Bailouts: Government bailouts of banks can stimulate aggregate demand by reducing systemic risk.
Interaction between Systemic Risk and Aggregate Demand
- Dynamic Interplay: The dynamic interplay between aggregate demand and systemic risk gives rise to a social cost of issuing private safe assets in this model.
- Composition of Safe Assets: The composition of safe assets between private and public affects aggregate demand and the level of systemic risk.
- Macroeconomic Spillover: The macroeconomic spillover from crises to future labor income affects the demand for safe assets and aggregate demand.
Actionable Insights
- Policy Coordination: The report suggests that coordination between monetary, fiscal, and macroprudential policies is crucial in managing systemic risk and stabilizing aggregate demand.
- Role of Public Safe Assets: Increasing the supply of public safe assets can help reduce systemic risk and stimulate aggregate demand, suggesting a need for governments to consider their role in safe asset creation.
- Macroprudential Policies: Macroprudential policies that reduce systemic risk can stimulate aggregate demand, indicating the importance of such policies in managing economic stability.
