Safe Asset Scarcity and Aggregate Demand

12 Pages Posted: 1 Mar 2016 Last revised: 27 Mar 2022

See all articles by Ricardo J. Caballero

Ricardo J. Caballero

Massachusetts Institute of Technology (MIT) - Department of Economics; National Bureau of Economic Research (NBER)

Emmanuel Farhi

Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

Pierre-Olivier Gourinchas

University of California, Berkeley - Department of Economics; University of California, Berkeley - Economic Analysis & Policy Group; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

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Date Written: February 2016

Abstract

We explore the consequences of safe asset scarcity on aggregate demand in a stylized IS-LM/Mundell Fleming environment. Acute safe asset scarcity forces the economy into a “safety trap” recession. In the open economy, safe asset scarcity spreads from one country to the other via capital flows, equalizing interest rates. Acute global safe asset scarcity forces the economy into a global safety trap. The exchange rate becomes indeterminate but plays a crucial role in both the distribution and the magnitude of output adjustment across countries. Policies that increase the net supply of safe assets somewhere are output enhancing everywhere.

Suggested Citation

Caballero, Ricardo J. and Farhi, Emmanuel and Gourinchas, Pierre-Olivier, Safe Asset Scarcity and Aggregate Demand (February 2016). NBER Working Paper No. w22044, Available at SSRN: https://ssrn.com/abstract=2739569

Ricardo J. Caballero (Contact Author)

Massachusetts Institute of Technology (MIT) - Department of Economics ( email )

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Emmanuel Farhi

Harvard University - Department of Economics ( email )

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Pierre-Olivier Gourinchas

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University of California, Berkeley - Economic Analysis & Policy Group ( email )

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National Bureau of Economic Research (NBER)

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Centre for Economic Policy Research (CEPR)

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