Is there a safe asset shortage?

Consider my previous hypothesis that so many yields have gone negative because of the insurance value of those relatively safe assets.  If that were true (true to some extent, I am not claiming that is the only factor behind the supply and demand curves), could a problem be solved by issuing more safe assets?  That could be done through more government spending or big tax cuts, either creating more government borrowing and thus more safe assets.

I often see it taken for granted that “selling more insurance” into the face of market demand would be a good thing.  And maybe so.  But it doesn’t follow in any simple way from theory, as is sometimes implied.  For one thing, this isn’t a straightforward market setting but rather there is a monopoly supplier that is not selling market outputs, and furthermore the private and social returns to either insurance or risk-taking are not in general equal.

So ask yourself which has a higher social rate of return?

1. How the government would spend marginal funds, plus relatively wealthy people buying more insurance

2. How private consumers would spend a tax cut, plus relatively wealthy people buying more insurance

3. Relatively wealthy people allocating more funds to riskier investments, and not getting that additional insurance

There is no way to tell, not from theory or for that matter from any kind of simple, straightforward empirics.  And from a social point of view, we therefore do not know if more safe assets should be put on the market.  There is of course a fourth possibility:

4. Because private investors enjoy more safe assets, they end up taking greater risks and the whole PPF shifts out

Again maybe, maybe not.  If it is true, a variety of subsidies to insurance markets, implicit or explicit, could improve welfare.  That is in contrast to Kenneth Arrow’s older argument that it is the risky investments that need to be subsidized and subsidized directly.  I say there is only so much “crowding in” to be had, especially during a time of near-full employment.

Another argument might be:

5. Selling more safe assets would raise nominal yields and make monetary policy potent again

I don’t want to go through all of that again, but suffice to say it had a better chance of being true in 2010 than today.  Here is John Cochrane on related issues.


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