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A Model of the Safe Asset Mechanism (SAM): Safety Traps and Economic Policy

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  • Ricardo J. Caballero
  • Emmanuel Farhi

Abstract

The global economy has a chronic shortage of safe assets which lies behind many recent macroeconomic imbalances. This paper provides a simple model of the Safe Asset Mechanism (SAM), its recessionary safety traps, and its policy antidotes. Public debt plays a central role in SAM as long as the government has spare fiscal capacity to back safe asset production. We show that Quantitative Easing type policies have positive eff ects on spreads and output. In contrast, Operation Twist type policies, where the duration of public debt held by the public is reduced, can be counterproductive. Monetary policy commitments work if they support future bad states of nature. All these policies depend on fi scal capacity. Once the latter runs out, short term cyclical policy becomes ineff ective. In contrast, credible long run fiscal consolidation relaxes the fi scal capacity constraint and enhances the e ffectiveness of short term policy. An economy that is near its scal limits is susceptible to runs on its public debt and to destabilizing feedback loops.

Suggested Citation

  • Ricardo J. Caballero & Emmanuel Farhi, 2013. "A Model of the Safe Asset Mechanism (SAM): Safety Traps and Economic Policy," Working Paper 70936, Harvard University OpenScholar.
    • Handle: RePEc:qsh:wpaper:70936
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    More about this item

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy
    • F3 - International Economics - - International Finance
    • F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • G01 - Financial Economics - - General - - - Financial Crises
    • G1 - Financial Economics - - General Financial Markets

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