Private Money Creation with Safe Assets and Term Premia

Abstract

It has been documented that an increase in the demand for safe assets induces the private sector to create more money-like claims. Focusing on private repos backed by U.S. Treasury securities, I show that an increase in the demand for safe assets leads to a decreases in the issuance of Treasury repos. The intuition is that Treasury securities already function as a safe asset, thus in terms of safe asset creation, private Treasury repos are neutral. In the model, Treasury repos are beneficial because they shift risk (i.e. term premia) from relatively risk averse households to a more risk tolerant financial sector, which issues repos to finance its portfolio. When the demand for safe assets increases, Treasury securities are reallocated to households, reducing the amount of Treasury repo issued by the financial sector. By contrast, Treasury repos created by the Federal Reserve's RRP program-a safe asset created by the public sector-increase with the demand for safe assets. I show the data supports the model's main predictions. *

The Collateral Link between Volatility and Risk Sharing

“…Our framework is consistent with the work of Greenwood et al (2015), Krishnamurthy and Vissing-Jorgensen (2015), and Sunderam (2014), who document the crowding out effect of public assets on private asset creation, and with Infante (2020), who points out that this sensitivity depends on whether the underlying collateral is publicly or privately produced. Our framework is also consistent with Mankiw (1986) and Constantinides and Duffie (1996) who show that risk premia increases if idiosyncratic shocks become more volatile during economic contractions.…”

The Private Production of Safe Assets

“…In contrast, assets issued by nonfinancial institutions do not exhibit clear patterns of substitution and safety. Furthermore, consistent with recent evidence based on U.S. data in Infante (2020), we show that the issuance of repo contracts in France and Germany decreases in times of excess demand for safety.…”

Monetary Policy Disconnect

“…In the wake of a negative supply shock (i.e., fewer banks need to borrow liquidity), the GC rate can fall below the deposit facility rate, creating an incentive to deposit liquidity at the central bank for banks that have the privilege to do so. The demand of nonaccess banks for investing liquidity in repos remains inelastic for various reasons, such as opportunity cost (benefits) of (from) pledging (obtaining) collateral (Bechtel, Eisenschmidt, and Ranaldo, 2019;Piquard and Salakhova, 2019) creating a net demand for safe assets (Infante, 2020), regulatory reasons (Ranaldo, Schaffner, and Vasios, 2020), and capacity constraints as well as limits to arbitrage in the unsecured money market (Nyborg, 2019). As a consequence, the dispersion between repo rates lent by access and nonaccess banks widens.…”

“…Repos are mostly secured by government bonds, which are safe assets per se, carrying convenience yields in the form of safety and liquidity benefits. Opportunity cost (benefits) of (from) pledging (obtaining) collateral (Bechtel, Eisenschmidt, and Ranaldo, 2019;Piquard and Salakhova, 2019) therefore create a net demand for safe assets (Infante, 2020). Second, financial regulation incentivizes directly and indirectly banks to hold secured deposits (Ranaldo, Schaffner, and Vasios, 2020).…”