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Ideas for Developing Asia and the Pacific

The Nexus of Safe Asset Shortage, Credit Growth, and Financial Instability

Publication | July 2020
The Nexus of Safe Asset Shortage, Credit Growth, and Financial Instability

Does a shortage of safe assets sow the seeds of instability in a financial system?

We empirically explore the hypothesis of safe asset shortage-induced excess credit booms and financial instability. As an alternative step forward from the assumption of growth- or wealth-based demands for safe assets, we underline demographic factors as a key determinant of safe asset demands. Based on the long-run trends of aging and government debt, we construct a new safe asset shortage index. Using the index, consecutive empirical exercises confirm the positive relationship of safe asset shortage-credit expansion-aggregate risks of a financial system. The estimation of the crisis probabilistic model for 17 advanced economies in 1960–2013 presents new evidence that the (high) level of private credit at a time of increasing safe asset shortage is the major predictor of financial crises. The fixed-effect panel analysis results for 18 advanced countries in 1980–2016 also show a significant, positive contribution of a safe asset shortage to credit growth. The total effect of the shortage depends positively on securitization growth and negatively on net capital outflows. The latter effect is considerably dominant.

WORKING PAPER NO: 1163