Markus Brunnermeier - Keynote at World Finance Conference "Safe Assets"
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Princeton Professor Markus Brunnermeier - Keynote at World Finance Conference "Safe Assets" Presentation Date: Saturday, July 30, 2016 Location: New York City, Cooper Union http://scholar.princeton.edu/markus/presentations/keynote-word-finance-conference
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Markus Brunnermeier - Keynote at World Finance Conference "Safe Assets"
- 1. Brunnermeier&Sannikov Safe Assets with Valentin Haddad The I Theory of Money - Money & Banking with Asset Pricing Tools - with Yuliy Sannikov Princeton University World Finance Conference New York City, July 30th, 2016
- 2. Brunnermeier&Sannikov Definitions of Safe Asset 1. Safe = risk-free for a particular horizon • But inflation risk • E.g. holders are infinitely risk aversion - Caballero & Farhi 2. Safe = informationally insensitive • No decline in value due to asymmetric info 3. Safe = “Good friend analogy” • Safe for random horizon • Appreciates in times of crisis Safe = “Safe Asset Tautology” • Safe because perceived to be safe (multiple equilibria) • Bubble Brunnermeier & Haddad
- 3. Brunnermeier&Sannikov Definitions of Safe Asset 1. Safe = risk-free for a particular horizon • E.g. holders are infinitely risk aversion Caballero & Farhi • … but inflation risk 2. Safe = informationally insensitive • No decline in value due to asymmetric info 3. Safe = “Good friend analogy” • Safe for random horizon • Appreciates in times of crisis Safe = “Safe Asset Tautology” • Safe because perceived to be safe (multiple equilibria) • Bubble Brunnermeier & Haddad Holmstrom & Gordon
- 4. Brunnermeier&Sannikov Safe asset & money - close cousins Store of value store of value • Held in addition to risky assets • Held in order to produce (private) safe assets (by banks!) Reference/benchmark asset unit of account Good collateral: stable margins transaction role • Facilitates financial trade Pool of risky high yield assets Safe asset Deposits Equity
- 5. Brunnermeier&Sannikov Safety versus Risk US Treasury downgraded by S&P (due to default risk) • … but yield declines German CDS spread versus yield during Euro crisis
- 6. Brunnermeier&Sannikov “Money and Banking” (in macro-finance) Money store of value/safe asset Banking “diversifier” holds risky assets, issues inside money Amplification/endogenous risk dynamics • Value of capital declines due to fire-sales Liquidity spiral Flight to safety • Value of money rises Disinflation spiral a la Fisher Demand for money rises – less idiosyncratic risk is diversified Supply for inside money declines – less creation by intermediaries • Endogenous money multiplier = f(capitalization of critical sector) • Paradox of Thrift (in risk terms) Monetary Policy (redistributive)
- 7. Brunnermeier&Sannikov “Money and Banking” (in macro-finance) Money store of value/safe asset Banking “diversifier” holds risky assets, issues inside money Amplification/endogenous risk dynamics • Value of capital declines due to fire-sales Liquidity spiral Flight to safety • Value of money rises Disinflation spiral a la Fisher Demand for money rises – less idiosyncratic risk is diversified Supply for inside money declines – less creation by intermediaries • Endogenous money multiplier = f(capitalization of critical sector) • Paradox of Thrift (in risk terms) Monetary Policy (redistributive) Paradox of Prudence
- 8. Brunnermeier&Sannikov “Money and Banking” (in macro-finance) Money store of value/safe asset Banking “diversifier” holds risky assets, issues inside money Amplification/endogenous risk dynamics • Value of capital declines due to fire-sales Liquidity spiral Flight to safety • Value of money rises Disinflation spiral a la Fisher Demand for money rises – less idiosyncratic risk is diversified Supply for inside money declines – less creation by intermediaries • Endogenous money multiplier = f(capitalization of critical sector) • Paradox of Thrift (in risk terms) Monetary Policy (redistributive) Paradox of Prudence
- 9. Brunnermeier&Sannikov Risk, Monetary & Macropru Policy Risk • Exogenous risk Sector-specific systematic cash flow risk Idiosyncratic • Endogenous risk Shifts in wealth share systemic risk Variation in risk premia Risk management • Monetary policy as “risk transfer” Affects (relative) asset prices reduces systemic risk • Macroprudential policy Affects/limits quantities/risk taking
- 10. Brunnermeier&Sannikov Roadmap Safe assets and money: close cousins Model absent monetary policy • Toy model: one sector with outside money • Two sector model with outside money • Adding intermediary sector and inside money Model with monetary policy The Curse of Safe Assets ESBies: securitization and safe assets
- 11. Brunnermeier&Sannikov One sector basic model 𝐴1 Technologies 𝑎 Each household can only operate one firm • Physical capital • Output Demand for money sector idiosyncratic risk 𝑦𝑡 = 𝐴𝑘 𝑡 𝑑𝑘 𝑡 𝑘 𝑡 = (Φ 𝜄 𝑡 − 𝛿)𝑑𝑡 + 𝜎 𝑎 𝑑𝑍𝑡 𝑎 + 𝜎𝑑 ෨𝑍𝑡 𝑎
- 12. Brunnermeier&Sannikov Adding outside money Technologies 𝑎 Each household can only operate one firm • Physical capital • Output Demand for money 𝑑𝑘 𝑡 𝑘 𝑡 = (Φ 𝜄 𝑡 − 𝛿)𝑑𝑡 + 𝜎 𝑎 𝑑𝑍𝑡 𝑎 + 𝜎𝑑 ෨𝑍𝑡 𝑎 sector idiosyncratic risk A L A L A L A L 𝐴1 Money Networth Outside Money 𝑦𝑡 = 𝐴𝑘 𝑡 𝑞𝑡 𝐾𝑡 value of physical capital • Postulate constant 𝑞𝑡 𝐴−𝜄 𝑞 𝑑𝑡 + Φ(𝜄 − 𝛿) 𝑑𝑡 + 𝜎 𝑏 𝑑𝑍𝑡 𝑏 + 𝜎𝑑 ෨𝑍𝑡 𝑏 𝑝𝑡 𝐾𝑡 value of outside money • Postulate value of money changes proportional to 𝐾𝑡
- 13. Brunnermeier&Sannikov Adding outside money Technologies 𝑎 Each household can only operate one firm • Physical capital • Output Demand for money 𝑑𝑘 𝑡 𝑘 𝑡 = (Φ 𝜄 𝑡 − 𝛿)𝑑𝑡 + 𝜎 𝑎 𝑑𝑍𝑡 𝑎 + 𝜎𝑑 ෨𝑍𝑡 𝑎 sector idiosyncratic risk A L A L A L A L 𝐴1 Money Networth Outside Money 𝑞𝐾𝑡 value of physical capital • 𝑑𝑟 𝑎 = 𝐴−𝜄 𝑞 𝑑𝑡 + Φ(𝜄 − 𝛿) 𝑑𝑡 + 𝜎 𝑎 𝑑𝑍𝑡 𝑎 + 𝜎𝑑 ෨𝑍𝑡 𝑎 𝑝𝐾𝑡 value of outside money • 𝑑𝑟 𝑀 = Φ(𝜄 − 𝛿) 𝑔 𝑑𝑡 + 𝜎 𝑎 𝑑𝑍𝑡 𝑎 𝑦𝑡 = 𝐴𝑘 𝑡
- 14. Brunnermeier&Sannikov Demand with 𝐸 0 ∞ 𝑒−𝜌𝑡 log 𝑐𝑡 𝑑𝑡 Technologies 𝑎 A L A L A L A L Money Networth Outside Money 𝑞𝐾𝑡 value of physical capital • 𝑑𝑟 𝑎 = 𝐴−𝜄 𝑞 𝑑𝑡 + Φ(𝜄 − 𝛿) 𝑑𝑡 + 𝜎 𝑎 𝑑𝑍𝑡 𝑎 + 𝜎𝑑 ෨𝑍𝑡 𝑎 𝑝𝐾𝑡 value of outside money • 𝑑𝑟 𝑀 = Φ(𝜄 − 𝛿) 𝑔 𝑑𝑡 + 𝜎 𝑎 𝑑𝑍𝑡 𝑎 Consumption demand: 𝜌 𝑝 + 𝑞 𝐾𝑡 = 𝐴 − 𝜄 𝐾𝑡 Asset (share) demand 𝑥 𝑎: 𝐸 𝑑𝑟 𝑎 − 𝑑𝑟 𝑀 /𝑑𝑡 = 𝐶𝑜𝑣[𝑑𝑟 𝑎 − 𝑑𝑟 𝑀 , ต 𝑑𝑛 𝑡 𝑎 𝑛 𝑡 𝑎 𝑑𝑟 𝑀+𝑥 𝑎 𝑑𝑟 𝑎−𝑑𝑟 𝑀 ] = 𝑥 𝑎 𝜎2 𝑥 𝑎 = 𝐸 𝑑𝑟 𝑎−𝑑𝑟 𝑀 /𝑑𝑡 𝜎2 = (𝐴−𝜄)/𝑞 𝜎2 = 𝑞 𝑞+𝑝 Investment rate: (Tobin’s q) Φ′ 𝜄 = 1/𝑞 • For Φ 𝜄 = 1 𝜅 log(𝜅𝜄 + 1) ⇒ 𝜄∗ = 𝑞−1 𝜅 𝐴1
- 15. Brunnermeier&Sannikov Demand with log-utility Technologies 𝑎 A L A L A L A L Money Networth Outside Money 𝑞𝐾𝑡 value of physical capital • 𝑑𝑟 𝑎 = 𝐴−𝜄 𝑞 𝑑𝑡 + Φ(𝜄 − 𝛿) 𝑑𝑡 + 𝜎 𝑎 𝑑𝑍𝑡 𝑎 + 𝜎𝑑 ෨𝑍𝑡 𝑎 𝑝𝐾𝑡 value of outside money • 𝑑𝑟 𝑀 = Φ(𝜄 − 𝛿) 𝑔 𝑑𝑡 + 𝜎 𝑎 𝑑𝑍𝑡 𝑎 Consumption demand: 𝜌 𝑝 + 𝑞 𝐾𝑡 = 𝐴 − 𝜄 𝐾𝑡 Asset (share) demand 𝑥 𝑎: 𝐸 𝑑𝑟 𝑎 − 𝑑𝑟 𝑀 /𝑑𝑡 = 𝐶𝑜𝑣[𝑑𝑟 𝑎 − 𝑑𝑟 𝑀 , ต 𝑑𝑛 𝑡 𝑎 𝑛 𝑡 𝑎 𝑑𝑟 𝑀+𝑥 𝑎 𝑑𝑟 𝑎−𝑑𝑟 𝑀 ] = 𝑥 𝑎 𝜎2 𝑥 𝑎 = 𝐸 𝑑𝑟 𝑎−𝑑𝑟 𝑀 /𝑑𝑡 𝜎2 = (𝐴−𝜄)/𝑞 𝜎2 = 𝑞 𝑞+𝑝 Investment rate: (Tobin’s q) Φ′ 𝜄 = 1/𝑞 • For Φ 𝜄 = 1 𝜅 log(𝜅𝜄 + 1) ⇒ 𝜄∗ = 𝑞−1 𝜅 𝐴1
- 16. Brunnermeier&Sannikov Demand with log-utility Technologies 𝑎 A L A L A L A L Money Networth Outside Money 𝑞𝐾𝑡 value of physical capital • 𝑑𝑟 𝑎 = 𝐴−𝜄 𝑞 𝑑𝑡 + Φ(𝜄 − 𝛿) 𝑑𝑡 + 𝜎 𝑎 𝑑𝑍𝑡 𝑎 + 𝜎𝑑 ෨𝑍𝑡 𝑎 𝑝𝐾𝑡 value of outside money • 𝑑𝑟 𝑀 = Φ(𝜄 − 𝛿) 𝑔 𝑑𝑡 + 𝜎 𝑎 𝑑𝑍𝑡 𝑎 Consumption demand: 𝜌 𝑝 + 𝑞 𝐾𝑡 = 𝐴 − 𝜄 𝐾𝑡 Asset (share) demand 𝑥 𝑎: 𝐸 𝑑𝑟 𝑎 − 𝑑𝑟 𝑀 /𝑑𝑡 = 𝐶𝑜𝑣[𝑑𝑟 𝑎 − 𝑑𝑟 𝑀 , ต 𝑑𝑛 𝑡 𝑎 𝑛 𝑡 𝑎 𝑑𝑟 𝑀+𝑥 𝑎 𝑑𝑟 𝑎−𝑑𝑟 𝑀 ] = 𝑥 𝑎 𝜎2 𝑥 𝑎 = 𝐸 𝑑𝑟 𝑎−𝑑𝑟 𝑀 /𝑑𝑡 𝜎2 = (𝐴−𝜄)/𝑞 𝜎2 = 𝑞 𝑞+𝑝 Investment rate: (Tobin’s q) Φ′ 𝜄 = 1/𝑞 • For Φ 𝜄 = 1 𝜅 log(𝜅𝜄 + 1) ⇒ 𝜄 = 𝑞−1 𝜅 𝐴1
- 17. Brunnermeier&Sannikov Market clearing Technologies 𝑎 A L A L A L A L Money Networth Outside Money 𝑞𝐾𝑡 value of physical capital • 𝑑𝑟 𝑎 = 𝐴−𝜄 𝑞 𝑑𝑡 + Φ(𝜄 − 𝛿) 𝑑𝑡 + 𝜎 𝑎 𝑑𝑍𝑡 𝑎 + 𝜎𝑑 ෨𝑍𝑡 𝑎 𝑝𝐾𝑡 value of outside money • 𝑑𝑟 𝑀 = Φ(𝜄 − 𝛿) 𝑔 𝑑𝑡 + 𝜎 𝑎 𝑑𝑍𝑡 𝑎 Consumption demand: 𝜌 𝑝 + 𝑞 𝐾𝑡 = 𝐴 − 𝜄 𝐾𝑡 Asset (share) demand 𝑥 𝑎: 𝐸 𝑑𝑟 𝑎 − 𝑑𝑟 𝑀 /𝑑𝑡 = 𝐶𝑜𝑣[𝑑𝑟 𝑎 − 𝑑𝑟 𝑀 , ต 𝑑𝑛 𝑡 𝑎 𝑛 𝑡 𝑎 𝑑𝑟 𝑀+𝑥 𝑎 𝑑𝑟 𝑎−𝑑𝑟 𝑀 ] = 𝑥 𝑎 𝜎2 𝑥 𝑎 = 𝐸 𝑑𝑟 𝑎−𝑑𝑟 𝑀 /𝑑𝑡 𝜎2 = (𝐴−𝜄)/𝑞 𝜎2 = 𝑞 𝑞+𝑝 Investment rate: (Tobin’s q) Φ′ 𝜄 = 1/𝑞 • For Φ 𝜄 = 1 𝜅 log(𝜅𝜄 + 1) ⇒ 𝜄 = 𝑞−1 𝜅 𝐴1
- 18. Brunnermeier&Sannikov Equilibrium Moneyless equilibrium Money equilibrium 𝑝0 = 0 𝑝 = 𝜎− 𝜌 𝜌 𝑞 𝑞0 = 𝜅𝐴+1 𝜅𝜌+1 𝑞 = 𝜅𝐴+1 𝜅 𝜌𝜎+1 𝜎𝜌 𝑝 𝑞 0 𝑞0 >
- 19. Brunnermeier&Sannikov Welfare analysis Moneyless equilibrium Money equilibrium 𝑝0 = 0 𝑝 = 𝜎− 𝜌 𝜌 𝑞 𝑞0 = 𝜅𝐴+1 𝜅𝜌+1 𝑞 = 𝜅𝐴+1 𝜅 𝜌𝜎+1 𝑔0 𝑔 welfare0 welfare< > >
- 20. Brunnermeier&Sannikov Roadmap Safe assets and money: close cousins Model absent monetary policy • Toy model: one sector with outside money • Two sector model with outside money • Adding intermediary sector and inside money Model with monetary policy The Curse of Safe Assets ESBies: securitization and safe assets
- 21. Brunnermeier&Sannikov 𝐴1 𝐴1 Outline of two sector model 𝐴1 𝐵1 SwitchSwitch technology Technologies 𝑎 Technologies 𝑏 Households have to • Specialize in one subsector sector specific + idiosyncratic risk for one period • Demand for money 𝑑𝑘 𝑡 𝑘 𝑡 = ⋯ 𝑑𝑡 + 𝜎 𝑏 𝑑𝑍𝑡 𝑏 + 𝜎𝑑 ෨𝑍𝑡 𝑏 𝑑𝑘 𝑡 𝑘 𝑡 = ⋯ 𝑑𝑡 + 𝜎 𝑎 𝑑𝑍𝑡 𝑎 + 𝜎𝑑 ෨𝑍𝑡 𝑎
- 22. Brunnermeier&Sannikov Add outside money Households have to • Specialize in one subsector for one period • Demand for money Outside Money A L A L A Money 𝐵1 L Networth Technologies 𝑎 Technologies 𝑏 SwitchSwitch technology A L A L A L A L 𝐴1 Money Networth
- 23. Brunnermeier&Sannikov Roadmap Safe assets and money: close cousins Model absent monetary policy • Toy model: one sector with outside money • Two sector model with outside money • Adding intermediary sector and inside money Model with monetary policy The Curse of Safe Assets ESBies: securitization and safe assets
- 24. Brunnermeier&Sannikov Roadmap Model absent monetary policy • Toy model: one sector with outside money • Two sector model with outside money • Adding intermediary sector and inside money Model with monetary policy Model with macro-prudential policy
- 25. Brunnermeier&Sannikov Technologies 𝑏 • Risk can be partially sold off to intermediaries Add intermediaries Net worth A L Outside Money A L A L A Money 𝐵1 L Networth Technologies 𝑎 • Risk is not contractable (Plagued with moral hazard problems) A L A L A L A L 𝐴1 Money Networth
- 26. Brunnermeier&Sannikov Technologies 𝑏 Add intermediaries Net worth A L Outside Money Intermediaries • Can hold outside equity & diversify within sector 𝑏 • Monitoring A L A L A Money 𝐵1 L Networth Technologies 𝑎 A L A L A L A L 𝐴1 Money Networth
- 27. Brunnermeier&Sannikov Technologies 𝑏 A L RiskyClaim A L RiskyClaim Add intermediaries … Net worth A L RiskyClaim RiskyClaim RiskyClaim Outside Money A L 𝐵1 Money RiskyClaim Insideequity Intermediaries • Can hold outside equity & diversify within sector 𝑏 • Monitoring Technologies 𝑎 A L A L A L A L 𝐴1 Money Networth
- 28. Brunnermeier&Sannikov A L RiskyClaim A L RiskyClaim Add intermediaries Technologies 𝑏 … Net worth Inside Money (deposits) A L Outside Money Pass through RiskyClaim RiskyClaim RiskyClaim Outside Money Intermediaries • Can hold outside equity & diversify within sector 𝑏 • Monitoring • Create inside money • Maturity/liquidity transformation A L 𝐵1 Money RiskyClaim Insideequity A L A L A L A L 𝐴1 Money HHNetworth Technologies 𝑎
- 29. Brunnermeier&Sannikov Technologies 𝑏 A L RiskyClaim A L Shock impairs assets: 1st of 4 steps Technologies 𝑎 … Net worth Inside Money (deposits) A L Outside Money Pass through RiskyClaim RiskyClaim RiskyClaim Losses A L 𝐴1 Money RiskyClaim Insideequity 𝐵1 A L A L A L A L 𝐴1 Money HHNetworth
- 30. Brunnermeier&Sannikov Technologies 𝑏 Shrink balance sheet: 2nd of 4 steps A Technologies 𝑎 Inside Money (deposits) … Net worth Inside Money (deposits) A L Pass through Losses Deleveraging Deleveraging … RiskyClaim RiskyClaim RiskyClaim Outside Money Switch A L RiskyClaim A L A L 𝐴1 Money RiskyClaim Insideequity 𝐵1 A L A L A L A L 𝐴1 Money HHNetworth “Paradox of Prudence”
- 31. Brunnermeier&Sannikov Technologies 𝑏 Liquidity spiral: asset price drop: 3rd of 4 Technologies 𝑎 Switch A L RiskyClaim A L A L 𝐴1 Money RiskyClaim Insideequity 𝐵1 Inside Money (deposits) Outside Money … Net worth Inside Money (deposits) A L Pass through RiskyClaim RiskyClaim RiskyClaim Losses Deleveraging Deleveraging A L A L A L A L 𝐴1 Money HHNetworth
- 32. Brunnermeier&Sannikov Technologies 𝑎 Technologies 𝑏 Disinflationary spiral: 4th of 4 steps A L A L A L A L 𝐴1 Money HHNetworth A L RiskyClaim A L A L 𝐴1 Money RiskyClaim Insideequity 𝐵1 Inside Money (deposits) Outside Money … Net worth Inside Money (deposits) A L Pass through RiskyClaim RiskyClaim RiskyClaim Losses Deleveraging Deleveraging
- 33. Brunnermeier&Sannikov … after an adverse shock Intermediaries are hit and shrink their balance sheets inducing • Asset side liquidity spiral financial stability • Liability side disinflation spiral price stability Response of intermediaries to adverse shock leads to endogenous risk • Amplification • Persistence Other sectors can also be undercapitalized • Japan 1980: corporate sector • US 2000s: household sector
- 34. Brunnermeier&Sannikov Allocation Equilibrium is a map Histories of shocks prices 𝑞𝑡, 𝑝𝑡, 𝜆 𝑡, allocation 𝒁 𝜏, 0 ≤ 𝜏 ≤ 𝑡 𝛼 𝑡, 𝜒𝑡 & portfolio weights (𝑥 𝑡, 𝑥 𝑡 𝑎 , 𝑥 𝑡 𝑏 ) wealth distribution 𝜂 𝑡 = 𝑁𝑡 (𝑝 𝑡+𝑞 𝑡)𝐾𝑡 ∈ 0,1 intermediaries’ wealth share • All agents maximize utility Choose: portfolio, consumption, technology • All markets clear Consumption, capital, money, outside equity of 𝑏
- 35. Brunnermeier&Sannikov 0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1 0 0.5 1 1.5 2 2.5 3 p q p,q Numerical example: prices Disinflation spiral Liquidity spiral
- 36. Brunnermeier&Sannikov 0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1 0 0.5 1 1.5 2 2.5 3 p q p,q Numerical example: prices Disinflation spiral Liquidity spiral 𝜗 = 𝑝 𝑝+𝑞
- 37. Brunnermeier&Sannikov Numerical example: dynamics of 𝜂 𝜎𝑡 𝜂 = 𝑥𝑡 (𝜎 𝑏 1 𝑏 − 𝜎𝑡 𝐾 ) 1 − 𝑥 𝑡 1−𝜗𝑡 −1 −𝜗′ 𝜂 𝑡 𝜗/𝜂 𝑡 amplification leverage elasticity fundamental volatility Steady state
- 39. Brunnermeier&Sannikov Overview Safe assets No monetary economics • Fixed outside money supply • Amplification/endogenous risk through Liquidity spiral asset side of intermediaries’ balance sheet Disinflationary spiral liability side Monetary policy The Curse of Safe Assets ESBies: Creating Safety via Securitization
- 40. Brunnermeier&Sannikov Redistributive MoPo: Ex-post perspective Adverse shock value of risky claims drops Monetary policy • Interest rate cut ⇒ long-term bond price • Asset purchase ⇒ asset price • ⇒ “stealth recapitalization” - redistributive • ⇒ risk premia Liquidity & Deflationary Spirals are mitigated … Net worth Inside Money (deposits) A L Outside Money Pass through 𝑁𝑡 Bonds 𝑏𝑡 𝐾𝑡 𝜒𝑡 𝜓 𝑡 𝑞𝑡 𝐾𝑡
- 41. Brunnermeier&Sannikov Redistributive MoPo: Ex-post perspective Adverse shock value of risky claims drops Monetary policy • Interest rate cut ⇒ long-term bond price • Asset purchase ⇒ asset price • ⇒ “stealth recapitalization” - redistributive • ⇒ risk premia Liquidity & Deflationary Spirals are mitigated … Net worth Inside Money (deposits) A L Outside Money Pass through 𝑁𝑡 Bonds 𝑏𝑡 𝐾𝑡 𝜒𝑡 𝜓 𝑡 𝑞𝑡 𝐾𝑡
- 42. Brunnermeier&Sannikov Monetary policy and endogenous risk Intermediaries’ risk (borrow to scale up) 𝜎𝑡 𝜂 = 𝑥 𝑡 (1 𝑏 𝜎 𝑏 − 𝜎𝑡 𝐾 ) 1 + 𝜒 𝑡 𝜓 𝑡−𝜂 𝜂 𝑡 𝜗′ 𝜂 𝑡 𝜗/𝜂 𝑡 − 𝑥 𝑡 + 𝜗𝑡 1−𝜂 𝑡 𝜂 𝑡 𝑏𝑡 𝑝𝑡 𝐵′ 𝜂 𝑡 𝐵(𝜂 𝑡)/𝜂 𝑡 MoPo works through 𝐵′ 𝜂 𝑡 𝐵(𝜂 𝑡)/𝜂 𝑡 • with right monetary policy bond price 𝐵(𝜂) rises as 𝜂 drops “stealth recapitalization” • Switch off liquidity and disinflationary spiral Example: Remove amplification s.t. 𝜎𝑡 𝜂 = 𝑥 𝑡(1 𝑏 𝜎 𝑏 − 𝜎𝑡 𝐾 ) fundamental risk amplification mitigation
- 43. Brunnermeier&Sannikov 0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1 0 0.2 0.4 0.6 0.8 1 1.2 1.4 1.6 1.8 2 q, without policy q, with policy p, with policy p, without policy p,q Numerical example with monetary policy Prices 𝑞 is more stable 𝑝 less disinflation
- 44. Brunnermeier&Sannikov Overview Safe assets No monetary economics • Fixed outside money supply • Amplification/endogenous risk through Liquidity spiral asset side of intermediaries’ balance sheet Disinflationary spiral liability side Monetary policy The Curse of Safe Assets ESBies: Creating Safety via Securitization
- 45. Brunnermeier&Sannikov The “Curse of Safety” with Haddad Investment equilibrium • High real investment • High market liquidity of risky assets Less safe asset holdings necessary Pool of risky high yield assets Safe asset Equity Risky assets Safe asset Equity Safety equilibrium • Low real investment • Low market liquidity of risky assets High safe asset holdings necessary
- 46. Brunnermeier&Sannikov Overview Safe assets No monetary economics • Fixed outside money supply • Amplification/endogenous risk through Liquidity spiral asset side of intermediaries’ balance sheet Disinflationary spiral liability side Monetary policy The Curse of Safe Assets Asymmetrically supplied safe asset: ESBies solution
- 47. Brunnermeier&Sannikov The two “safe asset challenges” Challenge 1: Safe asset + sovereign debt restructuring w/o diabolic loop Challenge 2: No asymmetrically supplied safe asset • German Bund 66 French IMF/Anglo-American/German
- 48. Brunnermeier&Sannikov Cross-border flight to safety Today: asymmetric shifts across borders • Value of German debt increases German CDS spread rises, but yield on bund drops (flight to quality) • Value of Italian/Spanish/Greek… sovereign debt declines With ESBies: Negative co-movement • Value of ESBies expands – due to flight to quality • Value of Junior bond shrinks – due to increased risk • Asset side is more stable 67
- 49. Brunnermeier&Sannikov Solution: ESBies Today: asymmetric shifts across borders • Value of German debt increases German CDS spread rises, but yield on bund drops (flight to quality) • Value of Italian/Spanish/Greek… sovereign debt declines With ESBies: Negative co-movement across tranches • Value of ESBies expands – due to flight to quality • Value of Junior bond shrinks – due to increased risk • Asset side is more stable 68 sovereign bonds ESBies Junior Bond A L
- 50. Brunnermeier&Sannikov Conclusion Safe assets • “Good friend analogy” • Safe asset tautology (multiple equilibria, bubble) • Flight to safety Safe asset and Money are close cousins Amplification & endogenous risk– due to “Paradox of Prudence” • Liquidity spiral (fire sales etc.) • Disinflationay spiral Redistributive monetary policy Ex-ante insurance -> MH requires MacroPru regulation Curse of safe assets ESBies – symmetrically supplied for Europe
- 51. Brunnermeier&Sannikov The Euro & The Battle of Ideas Markus K. Brunnermeier, Harold James & Jean-Pierre Landau “interests are interpret through the lens of ideas”≈models ESBies and more …