A Global Safe Asset for & from Emerging Economies

Transcription

1 A Global Safe Asset for & from Emerging Economies Markus Brunnermeier Lunyang Huang Princeton University Princeton Initiative 2018 Princeton, Sept

2 International: Flight to Safety Risk-on, Risk-off Flight-to-safe asset If safe asset is asymmetrically supplied by AE Safe asset: Good friend analogy Safe asset tautology Flight-to-safety is around/valuable when you need it is safe because it is perceived to be safe Question: Who insures whom? Correct insurance only if buffer is large and debt long-term enough so that no new debt issuance needed & sell safe asset/reserves instead 2

3 International: Flight to Safety Risk-on, Risk-off Flight-to-safe asset Problem: Safe asset is asymmetrically supplied by AE Flight-to-safety cross-border capital flows At times of global crisis, issuance of new debt For AE at inflated prices eases conditions For EME at depressed prices worsens conditions Question: Who insures whom? Correct insurance only if buffer is large and debt long-term enough so that no new debt issuance needed & sell safe asset/reserves instead 3

4 International: Flight to Safety Risk-on, Risk-off Flight-to-safe asset Problem: Safe asset is asymmetrically supplied by AE Flight-to-safety cross-border capital flows At times of global crisis, issuance of new debt For AE at inflated prices eases conditions For EME at depressed prices worsens conditions Question: Who insures whom? Correct insurance only if buffer is large and debt long-term enough so that no new debt issuance needed & sell safe asset/reserves instead 4

5 International: Flight to Safety Risk-on, Risk-off Flight-to-safe asset Problem: Safe asset is asymmetrically supplied by AE Flight-to-safety cross-border capital flows At times of global crisis, issuance of new debt For AE at inflated prices eases conditions For EME at depressed prices worsens conditions Question: Who insures whom? Poor insure rich Paradox Correct insurance only if buffer is large and debt long-term enough so that no new debt issuance needed & sell safe asset/reserves instead 5

6 Two Approaches Approach 1: Buffer Approach (traditional) Lean against sudden stop (flight-to-safety) capital outflows Precautionary Reserves IMF liquidity lines Central Banks Swap line arrangements Official sector Approach 2: Rechanneling Approach (new proposal) Global Safe Asset from & for Emerging Economies with Lunyang Huang (Central Bank of Chile Conference 2017) formal analysis 6

7 1. Buffer Approach via Reserves Holdings South East Asia crisis 97/98: Sudden Stop/Flight-to-Safety precautionary reserves Source: Kieran (Wikipedia) CIA World Factbook data

8 1. Buffer Approach via Reserves Holdings South East Asia crisis 97/98: Sudden Stop/Flight-to-Safety precautionary reserves Negative carry due to low yield of safe asset (exorbitant privilege) As EME grows faster, it have to keep acquire foreign safe assets (export surplus required) Distorts exchange rates Subsidizes private carry trades Carry traders undermine/undo official reserve strategy EME corporate sector $-borrowing Bruno & Shin 2016 Hungarian/Polish household -borrowing Verner

9 1. Buffer Approach via Reserves Holdings South East Asia crisis 97/98: Sudden Stop/Flight-to-Safety precautionary reserves Negative carry due to low yield of safe asset (exorbitant privilege) As EME grows faster, they have to keep acquire foreign safe assets (export surplus required) Distorts exchange rates Subsidizes private carry trades Carry traders undermine/undo official reserve holding EME corporate sector $-borrowing Bruno & Shin 2016 Hungarian/Polish household -borrowing Verner

10 1. Buffer Approach via Reserves Holdings South East Asia crisis 97/98: Sudden Stop/Flight-to-Safety precautionary reserves Negative carry due to low yield of safe asset (exorbitant privilege) As EME grows faster, they have to keep acquire foreign safe assets (export surplus required) Distorts exchange rates Subsidizes private carry trades Carry traders undermine/undo official reserve holding EME corporate sector $-borrowing Bruno & Shin 2016 Hungarian/Polish household -borrowing Verner

11 2. Approach: Rechanneling Address root cause: Safe asset is supplied asymmetrically Analogy 11

12 2. Approach: Rechanneling Address root cause: Safe asset is supplied asymmetrically Analogy Flight-to-safety (weakens defense) Under attack/siege 12

13 2. Approach: Rechanneling Address root cause: Safe asset is supplied asymmetrically Analogy Two lines of defense Stronger inner circle (keep) Flight-to-safety (weakens defense) Under attack/siege 13

14 2. Approach: Rechanneling Address root cause: Safe asset is supplied asymmetrically Analogy Two lines of defense Stronger inner circle (keep) Flight-to-safety (weakens defense) Under attack/siege 14

15 2. Approach: Rechanneling Address root cause: Safe asset is supplied asymmetrically Create globally supplied safe asset via pooling & tranching Pool of Sovereign Bonds 15

16 2. Approach: Rechanneling Address root cause: Safe asset is supplied asymmetrically Create globally supplied safe asset via pooling & tranching A L Pooling Pool of Sovereign Bonds Senior Bond Junior Bond Tranching Expand ESBies idea for euro area to EME: SBBS (Sovereign-Bond Backed Securities) for the world Euro-nomics group 2011, 2016,

17 2. Approach: Rechanneling Address root cause: Safe asset is supplied asymmetrically Create globally supplied safe asset via pooling & tranching Pooling A Pool of Sovereign Bonds Senior Bond Junior Bond L Tranching Rechannel: Instead of cross-border Across asset classes Expand ESBies idea for euro area to EME: SBBS (Sovereign-Bond Backed Securities) for the world Euro-nomics group 2011, 2016,

18 International: Flight to Safety Risk-on, Risk-off Flight to safe asset Channels back some of flight-to-safety capital flows fewer cross-border capital flows Who insures whom? (rich the poor?) At times of global crisis issue new debt - for AE: at inflated prices - for EME: at depressed prices Question: is buffer large (long-term) enough s.t. no new debt issuance needed & sale off safe asset 18

19 RoadMap Motivation International: Flight to Safety Model Setup Ilustration More detail Policy Analysis Foreign Reserves: Buffering Approach Tranching: Rechanneling Approach Global Safe Asset from & for Emerging Market Economies 19

20 Model Setup 3 Dates: t = 0,1,2 Agents: entrepreneurs, households and foreigners Assets: Productive capital, domestic bonds and dollars Timeline: Debt issuance Invest in capital Sunspot (Possible) Flight to Safety Crisis Who insures whom? (rich the poor?) Capital payoffs Debt repayment/default At times tt = of 0 global crisis tt = 1 tt = issue 1 + new debt tt = 2 - for AE: at inflated prices - for EME: at depressed prices Question: is buffer largenough s.t. no new debt issuance needed & sale off safe asset More Detail 20

21 Assets Capital: Only entrepreneurs can invest at tt = 0 Output only at tt = 2: Entrepreneurs: yy 2 EE = AAKK 1 EE ; Foreigners: yy 2 = ηη AAKK 1 (ηη < 1) From tt = 1, capital can be traded among agents, price qq tt TFP Shock: 23

22 Assets con t Domestic Bonds: The government issues zero coupon bonds at tt = 0 Mature at tt = 2 with a total face value BB 0 Traded at tt = 0,1 at price pp tt The government can repay up to a maximal lump-sum tax TT 2 = ττ AAKK 1 EE i.e., RRRRRRRRRRRRRRRRRR = max {BB 0, TT 2 } Is perceived safe when bonds are not expected to be default Dollars/ Treasuries: Outside storage technology offers return RR $ per period Low risk-free yield 24

23 Agents Domestic Entrepreneurs Risk-neutral preferences: max E 0 [CC 0 + ββββ 1 + ββ 2 CC 2 ] The only agent that can invest in capital at tt = 0 (Exogenous) Safe asset demand/constraint : SS tt EE ββ 2 tt ααkk tt EE Possible safe assets: dollars, domestic bonds when they are nearly default free Prefer to invest minimal dollars: 1 RR $ > ββ Low Initial wealth WW 0 EE, not enough to buy all domestic bonds 25

24 Agents con t Domestic households The same preference as entrepreneurs Can not hold capitals Initial wealth WW 0 HH, buys the rest of domestic bonds at tt = 0 Foreigners Similar preference: max E 0 [CC 0 + ββ CC 1 + ββ 2 CC 2 ] Less patient than entrepreneurs: 1 RR $ > ββ > ββ Additionally: For simplicity, crisis is unanticipated at tt = 0 Debt-capital ratio dd = BB 0, bb EE = BB 0, bb HH = BB 0 KK 0 KK 0 EE dd = bb EE + bb HH HH KK 0 26

25 Equilibrium at tt = 0 Entrepreneurs: For sufficiently high AA, prefer Capital > Domestic bonds > consumption > dollars Hold domestic bonds for safe asset constraint: bb EE = BB 0 EE KK 0 = αα Households: Buy all residual bonds supply Indifferent between consumption and bonds: pp 0 = ββ 2, bb HH = dd αα Foreigners: Holding nothing due to impatience (low valuation) Equilibrium going forward depends on realization of TFP shock A A A Entrepreneurs EME Physical Capital Domestic Bonds Net worth Households EME Domestic Bonds Foreigners Net worth Unlimited Wealth L L L L 27

26 Equilibrium at tt = 1 Three possibilities: AA subgame equilibrium: Fundamental is strong, no crisis 28

27 AA subgame equilibrium at tt = 1 Similar to equilibrium at tt = 0 A A A Entrepreneurs EME L L L Strong fundamental ( AA) guarantees government repayment Physical Capital Domestic Bonds Net worth Asset positions unchanged Households EME Domestic Bonds Net worth L Asset price changes due to time discounting: qq 1,uu = ββaa, pp 1,uu = ββ 29

28 Equilibrium at tt = 1 Three possibilities: Fundamental E 1 AA equilibrium: Weak fundamental, but no sunspot triggers crisis 30

29 Fundamental E 1 AA -equilibrium at tt = 1 Similar to equilibrium at tt = 0 Weak fundamental ( AA) but market confidence makes government repayment self-fulfilling Gov. EME Tax capacity A A A Entrepreneurs EME Physical Capital Domestic Bonds Net worth L L L ττa KK 0 Tax Revenue Asset positions unchanged Domestic Bonds BB0 Households EME Domestic Bonds Net worth L Asset price changes due to time discounting: qq 1,ff = ββe 1 AA, pp 1,ff = ββ Foreigners Unlimited Wealth 31

30 Equilibrium at tt = 1 Three possibilities: Flight-to-Safety equilibrium: Weak fundamental, sunspot triggers crisis 32

31 Flight-to-Safety equilibrium at tt = 1 Flight to Safety: Entrepreneurs seek dollars Sell capital and bonds to foreigners at discounted price qq 1,ss = ββ ηη E 1 AA < qq 1,ff E 1 AA, Impatience Inefficiency pp 1,ss = ββ (1 ππ 2 h haircut ) Entrepreneurs hold capital KK EE 1,ss = qq 1,ssKK 0 +pp 1,ss BB 0 EE qq 1,ss +αααα = ββ ηηee 1 AA +ββ 1 ππ 2 h bb EE ββ ηηee 1 AA +αααα KK 0 = KK EE 1,ss (h) Self-fulfilling default: Assume default happens only if A realizes (No default for AA) Endogenous debt haircut: BB 0 1 h = ττ A KK EE 1,ss Crisis existence condition: h > 0 In Fundamental E 1 [ AA] equilibrium: dd < ττ A dd 1 h = ττa KK 1,ss EE KK 0 h 33

32 Self-fulfilling Debt Crisis 34

33 Crisis vulnerability and Severity Let xx be the policy parameter Crisis vulnerability: The area of dd (indebtedness) where a flight-to-safety crisis exists Intuition: For sufficiently low dd, implied h(dd) < 0 In the baseline model: VV BB xx = [max αα, dd bb, ττaa ], dd bb solves h(dd bb ) = 0 Crisis Severity: The fraction of capital fire sold in a crisis Output loss is linear in this measure In the baseline model: SS BB xx = max{0, ββ ηηee 1 AA + 1 ππ 2 ββ αα ββ ηηee 1 AA +ββββ ττaaββ αα ππ 2 dd Later analyze how policies affect these measure } 35

34 RoadMap Motivation International: Flight to Safety Model Setup Illustration More detail Policy Analysis Foreign Reserves: Buffering Approach Tranching: Rechanneling Approach Global Safe Asset from & for Emerging Market Economies 36

35 Foreign Reserves Implementation: The gov can issue additional bonds (purchased by households) for purchasing reserves Face value of additional bonds: bb RR KK 0 Since pp 0 = 1/ββ 2, reserves worth RR $2 /ββ 2 bb RR KK 0 RR $2 /ββ 2 bb RR KK 0 Gov. EME Reserve s($) Tax Revenue bb RR KK 0 New Bonds Old Bonds (bb EE + bb HH )KK 0 Benefit-cost analysis: Given debt hair cut h RR, RR $2 ββ 2 bbrr KK 0 1 h RR bb RR KK 0 = ( RR$2 ββ 2 1)bbRR KK 0 negative carry + h RR bb RR KK 0 debt forgiveness 37

36 Equilibrium Subgame equilibriums without crisis is similar Focus on flight-to-safety crisis with reserves Fire-sale of capital the same as in baseline KK EE 1,ss = qq 1,ssKK 0 +pp 1,ss BB 0 EE qq 1,ss +αααα Endogenous haircut h RR : (bb ee +bb h ) 1 h RR = ββ ηηee 1 AA +ββ 1 ππ 2 h RR bb EE ββ ηηee 1 AA +αααα KK 0 = KK EE 1,ss (h RR ) +bb RR (1 h RR ) = ττa KK 1,ss +bb RR (ββ 2 RR $2 ) KK 0 EE h 38

37 Equilibrium Subgame equilibriums without crisis is similar Focus on flight-to-safety crisis with reserves Fire-sale of capital the same as in baseline KK EE 1,ss = qq 1,ssKK 0 +pp 1,ss BB 0 EE qq 1,ss +αααα Endogenous haircut h RR : (bb ee +bb h ) 1 h RR = ββ ηηee 1 AA +ββ 1 ππ 2 h RR bb EE ββ ηηee 1 AA +αααα KK 0 = KK EE 1,ss (h RR ) +bb RR (1 h RR ) = ττa KK 1,ss +bb RR (ββ 2 RR $2 ) KK 0 New Debt Repayment Crisis existence condition: h RR > 0 EE h Reserves 39

38 Self-fulfilling Debt Crisis (With Reserves) 40

39 Crisis vulnerability and Severity (With Reserves) bb RR is the policy parameter here Crisis vulnerability: Compare to baseline: VV RR bb RR VV BB Intuition: At h RR = 0, no debt forgiveness but negative carry Crisis Severity: Compare to baseline: SS RR bb RR SS BB h RR 1 ββrr $ 2 h 1 ββrr $ 2 Intuition: If crisis is severe enough, debt forgiveness creates gain that exceeds negative carry 41

40 RoadMap Motivation International: Flight to Safety Model Setup Illustration More detail Policy Analysis Foreign Reserves: Buffering Approach Tranching: Rechanneling Approach Global Safe Asset from & for Emerging Market Economies 42

41 Tranching Implementation: Set up a SPV that purchases government bonds and issues a senior and junior bond. Default loss is first absorbed by junior bonds Total face value of senior bonds:sskk 0 < ddkk 0 Assume ss > αα, entrepreneurs are fully protected Notations: bb SS,EE, bb SS,HH, bb JJ,EE, bb JJ,HH Gov. EME Tax Revenue sskk 0 Senior Bonds Junior Bonds ddkk 0 Benefit-cost analysis: No cost within the model Senior bonds are less likely to lose safe-asset-status Owners of senior bonds (E) recover larger value even in defaults 43

42 Equilibrium Subgame equilibriums without crisis is similar At tt = 0, junior bonds and senior bonds are perfect substitutes Assume entrepreneurs slightly prefer senior bonds Focus on flight-to-safety crisis here Senior bonds haircut h SS > 0 h JJ = 1(Junior bonds wiped out) Fire-sale of capital the same as in baseline KK EE 1,ss = qq 1,ssKK 0 +pp SS SS,EE 1,ss BB 0 qq 1,ss +αααα Endogenous haircut h SS : Baseline: Crisis existence condition: h SS > 0 = ββ ηηee 1 AA +ββ 1 ππ 2 h SS bb SS,EE ββ ηηee 1 AA +αααα KK 0 = KK EE 1,ss (h SS ) (bb EE +bb HH ) 1 h = dd 1 h = ττaa KK 1,ss EE KK 0 h 44

43 Equilibrium Subgame equilibriums without crisis is similar At tt = 0, junior bonds and senior bonds are perfect substitutes Assume entrepreneurs slightly prefer senior bonds Focus on flight-to-safety crisis here Senior bonds haircut h SS > 0 h JJ = 1(Junior bonds wiped out) Fire-sale of capital the same as in baseline KK EE 1,ss = qq 1,ssKK 0 +pp SS SS,EE 1,ss BB 0 qq 1,ss +αααα Endogenous haircut h SS : = ββ ηηee 1 AA +ββ 1 ππ 2 h SS bb SS,EE ββ ηηee 1 AA +αααα KK 0 = KK EE 1,ss (h SS ) Tranching: (bb SS,EE +bb SS,HH ) 1 h SS = ss 1 h ss = ττaa KK 1,ss h SS can be solved from baseline model assume dd = ss Crisis existence condition: h SS > 0 Tranching is equivalent to eliminate dd ss debt burden in crisis EE KK 0 h SS 45

44 Crisis vulnerability and Severity (With Tranching) ss is the policy parameter here But αα ss dd Crisis vulnerability: Compare to baseline: VV TT ss = VV BB dd=ss VV BB Crisis Severity: Compare to baseline: SS TT ss = SS BB dd=ss SS BB 46

45 RoadMap Motivation International: Flight to Safety Model Setup Illustration More detail Policy Analysis Foreign Reserves: Buffering Approach Tranching: Rechanneling Approach Global Safe Asset from & for Emerging Market Economies 47

46 Tranching and Pooling Tranching can be strengthened via diversifying local shock generalize the model to a continuum of ex-ante identical countries Set up international SPV to implement GloSBBies 48

47 Policy Analysis (Tranching & Pooling) ss (senior bonds/capital) is the policy parameter But αα ss dd Crisis vulnerability: Crisis exists iff ss Issued safe asset ii > 1 ππ 2 dd ii + ππ 2 dd BB repyment of repyment of default free country defaulted country For national tranching, crisis exists iff ss > dd BB Crisis Severity: Compare to national tranching: SS GGGGGGGGGGGGGGGG ss < SS TT ss = SS BB dd=ss SS BB 49

48 Conclusion High Debt Level Domestic Challenge: International Challenge: Central Bank independence Flight-to-Safety Global Financial Architecture Buffer approach Reserve holding IMF support Swap lines Rechanneling approach interventionistic costly due to cost of carry & distortionary very limited Limited (not all IMF member countries) self-stabilizing (autonomous) Tranching completes the market Allows catering to investors groups with different risk attitudes Makes EME less crisis prone International pooling and tranching SBBS/ESBies for the world Expands IMF s fire power 50

49 Extra Slide: Safe assets Good friend analogy - like reserve assets Safe/available at any horizon - when it counts Precautionary buffer held in addition to more risky assets Risk demand for safe assets Safe asset tautology Safe because it is perceived to be safe Safe independent of fundamentals US Treasuries downgrade by S&P in 2011 yield German CDS spread yield during Euro crisis Multiple equilibria Bubble 51

50 Model Setup Three Dates: t = 0,1,2 Time 0: The government issues bonds maturing in date 2 Domestic agents invest capital and buy domestic bonds Time 1: Potential flight-to-safety crisis Capital and domestic bonds are fire sold to foreigners Time 2: Capital produces output The government partially defaults if tax revenue < maturing bonds Debt issuance Invest in capital Who insures whom? (rich the poor?) Sunspot (Possible)Flight to Safety Crisis Capital payoffs Debt repayment/default At times of global crisis issue new debt - for AE: at inflated prices tt = 0 tt = 1 tt = -1 + for EME: at depressed tt = 2 prices Question: is buffer large (long-term) enough Back s.t. no new debt issuance needed & sale off safe asset 52