Safe Assets, Collateralized Lending and Monetary Policy∗

I study how quantities of safe bonds affect asset prices and lending volumes in financial markets. In a quantitative model, heterogeneous agents trade securities of different maturity and risk exposure. Risk-tolerant investors issue collateralized bonds to obtain leverage and to insure the risk-averse. Despite the presence of higher return assets, the most risk-tolerant hold long-maturity safe assets, which they value as good collateral. The value of collateralizability is high when safe bond quantities are low. Given measured variations in safe bond quantities between 1990 and 2015, the model replicates the dynamics of lending volumes and generates large, volatile credit spreads and excess return predictability. The model also predicts price effects of high-frequency changes of government debt quantities around tax due dates. In policy experiments, I use the model to study the effects of central bank asset purchases. ∗I am deeply indebted to Monika Piazzesi and Martin Schneider for their invaluable guidance and support during my PhD, as well as to Patrick Kehoe, John Taylor and Chris Tonetti for many helpful conversations. I also thank Adrien Auclert, John Cochrane, Andres Drenik, Darrell Duffie, Egemen Eren, Eran Hoffman, Arvind Krishnamurthy, Pablo Kurlat, Serguei Maliar, Sean Myers, Alessandra Peter, Cian Ruane, Uwe Thümmel and Alonso Villacorta for helpful comments. Financial support from the Kohlhagen Fellowship Fund through a grant to the Stanford Institute for Economic Policy Research, the Weiland Research Fellowship and the Macro Financial Modeling Initiative is gratefully acknowledged. †Department of Economics, Stanford University, 579 Serra Mall, Stanford, CA, 94305. Email: [email protected]. Website: http://www.stanford.edu/~lenel.