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Safe Assets, Credit Provision and Debt Management

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Abstract

This paper analyses the interactions between the financial and the real sector in an environment where liquidity holdings is an input of the credit/investment process. The supply of liquidity is constrained in that income pledgeability limits inside liquidity, and there is a range of outside liquidity instruments that differ for safety and liquidity. We analyse the resulting equilibrium asset prices, collateral/liquidity-safety premia, liquidity instrument holdings and real investment. The model is applied to examine the implications of liquidity provision policies and debt management in the Euro Area. We analyse how the correlation structure of the bond market values affects the optimal composition of liquidity instrument holdings and prices, and formalize the concept of a European Safe Bond with a clear analysis of its potential advantages.

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Notes

  1. Krishnamurthy and Vissing-Jorgensen (2012) document that Treasuries offer money-like convenience services and these services are reflected in the pricing of Treasury securities. Von Hagen and Fender (1998) document the growing relevance of liquidity in nowadays financial systems and the broadening of monetary aggregates.

  2. Corporations’ concern for refinancing is emphasized in various contexts by the finance literature – Thakor et al. (1981) and Froot et al. (1993), among others.

  3. The importance of secured/collateralized government debt for a sounder euro area monetary system is emphasized by Nyborg (2011). The euro-nomics group (2011) points out the vital importance of a European safe asset for the long run survival of the euro-zone and calls for the creation of European Safe Bonds, where safeness is provided by pooling the sovereign bonds and then tranching the pooled debt so as to create a security whose safeness is ensured by sufficient collateral.

  4. In Lagos (2010) financial assets are valued for the degree to which they are useful in exchange for goods. In the same vein, Benigno and Nisticò (2017) analyse liquidity shocks as a decrease in the extent to which financial assets can be exchanged for consumption goods, and the role of central bank’s money expansion in coping with these shocks.

  5. The return on capital ρ ≡ \(\frac {R}{1+\underline {q}_{G}S}\) exceeds IMRS (by (8) and (A6)).

  6. The return on capital \(\rho \equiv \frac {R}{1+\overline {q}_{G}S}\) exceeds IMRS, i.e. ρ > 1 (by (A6)). If (A6) fails to hold, then, at equilibrium, n∗ firms/banks are active, where n∗ < N is the smallest integer such that \(\frac {R-1}{S}\geq q_{G}^{\ast }\equiv \)\( \frac {\sum \limits _{i=1}^{n^{\ast }}A_{i}-\frac {B^{G}}{S}}{B^{G}}\) (i.e. ρ ≥ 1).

  7. The return on capital \(\rho \equiv \frac {R}{1+QS}\) exceeds IMRS (by Q\( \leq \overline {q}_{G}\) and (A6)).

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Acknowledgments

I thank the Referee for extremely helpful comments and very insightful suggestions.

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  1. Department of Economics, University of Bologna, Bologna, Italy

    Gabriella Chiesa

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Chiesa, G. Safe Assets, Credit Provision and Debt Management. Open Econ Rev 31, 637–667 (2020). https://doi.org/10.1007/s11079-019-09542-w

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