The Stability of Safe Asset Production

November 09, 2020

The Stability of Safe Asset Production

Sara Almadani ¹, Michael Batty, Danielle Nemschoff, and Wayne Passmore*

A safe asset is a debt instrument that is expected to maintain its value over time, especially during adverse systemic events. Changes in the supply of safe assets can have a significant influence on short-term, risk-free interest rates. (Ferreira & Shousha, 2020) ‘When the scarcity of safe asset[s] is acute, the zero lower bound (ZLB) becomes binding and the safe asset market equilibrates via a reduction in output…’ (Caballero, Farhi, & Gourinchas , 2016).

The supply of safe assets has been concentrated in a small number of advanced economies: Germany, France, the United Kingdom, but most prominently by the United States. Despite their growing public sector deficits in these countries, the supply has not kept pace with the global demand in the past decade. Some observers attribute the lack of supply to the deceleration in the growth rate of the advanced economies relative to the world’s growth rate, as well as the rapid growth rate of high saving emerging economies in comparison with the advanced-economy public debt. (Caballero, Farhi, & Gourinchas, 2017)

One remarkable claim is the percentage of safe assets in the United States has remained very stable over time (see e.g. (Gorton, Lewellen, & Metrick, 2012) and (Gorton, 2017)). In particular, the fraction of safe assets to total assets in the economy has remained in a range between 30-35 percent during the past 7 decades. Here, we update the data on safe assets, as defined using the Financial Accounts of the United States (Z.1), and show that this claim is still true. We also update the components of safe assets and show that while the overall proportion has remained the same, there has been a significant shift in the components. For many years, the role of banks in the production of safe assets has been declining. But since the Great Financial Crisis (GFC), safe asset production has shifted back to depositories and away from shadow banking. Still, the declining contribution of banks remains notable.

The Stability of Safe Assets Hypothesis

Gorton, Lewellen, & Metrick (2012) uses information collected in the Federal Reserve’s Financial Accounts of the United States for the years 1952 to 2010. Figure 1 below updates the analysis through 2020. The red area represents the safe assets issued by U.S. federal, state, and local governments as a share of total assets in the U.S. economy, the blue area represents safe assets issued by the financial sector, and the dotted line indicates the average proportion of safe assets over the years 1952 to 2020 (31.1 percent). The standard deviation of the safe asset share has been 2.3 percent, suggesting that the hypothesis of a relatively constant proportion of safe assets remain true.

Calculating the Share of Safe Assets

Safe assets consist of selected liabilities issued by the financial and government sectors of the U.S. economy.² Government liabilities are explicitly backed by the United States, and are viewed as the ‘safest’ of safe assets. The financial liabilities we select are produced by the private sector and are deemed by investors as very safe (from credit risk). This clearly is a judgment call, and the judgments can vary across assets and across time. For example, the (time-varying) polices of governments and central banks are key to…