IM-Bailliu, Kronick and Wu_2023_0223.pub

Between the Great Financial Crisis and the beginning of the COVID pandemic, the supply of high-grade government bonds in advanced economies was limited by declining budget deficits. [...] At the effective lower bound of nominal interest rates, real rates on safe assets have limited room for downward adjustment, leaving the economy with higher rates relative to the rate that would restore balance between demand for savings and investments. [...] Howe Institute Working Paper examined three important questions related to safe asset shortages: First, we tested and found that between the financial crisis and the pandemic there was clear evidence of a safe asset shortage in Canada, with flat supply of safe assets alongside a widening equity risk premium (excess return investing in a risky versus safe asset), indicative of excess demand for saf. [...] We found that the higher debt would mostly come at the expense of Canadian output, and would have only a limited impact because it would not affect the global safe assets imbalance to which we are tied. [...] As a result, Canadian policymakers should work with other large demanders and suppliers of safe assets in settings such as the G7, the G20 and the Bank for International Settlements to avoid future shortages, which would exacerbate the stagnation of productive investments.