Department of Economics
Bendheim Center for Finance
Institutional Affiliation: Princeton University
NBER Working Papers and Publications
|December 2018||A Global Safe Asset for and from Emerging Market Economies|
with : w25373
This paper examines how a newly designed global safe asset can mitigate international capital flows induced by flight-to-safety. In the model domestic investors have to co-invest in a safe asset along with their physical capital. At times of crisis, investors replace the initially safe domestic government bonds with safe US Treasuries and re-sell part of their capital. The reduction in physical capital lowers GDP and tax revenue, leading to increased default risk justifying the loss of the government bond's safe-asset status. We compare two ways to mitigate this self-fulfilling scenario. In the “buffer approach” international reserve holding reduces the severity of a crisis. In the “rechannelling approach” flight-to-safety capital flows are rechannelled from international cross-border flow...