Annette Vissing-Jorgensen and Arvind Krishnamurthy have an interesting new paper that Annette presented at Berkeley yesterday. It’s a nice example of using a simple, tractable model to understand a very important issue – the demand for safe and liquid short-term assets & its impact on financial crises. Their story is that government debt is a substitute for the “net supply of privately issued short-term debt.”
This figure shows a few things. First, the supply of short term UST as a share of GDP is in blue and the available supply (ie net of what foreign central banks hold) is in red. It’s interesting to see how the red line diverges more since the 1980s as foreign central banks started holding more UST. Second, financial sector debt, which is mostly short-term (as shown by the difference between the total (green) and short term only (yellow) mirrors the supply of UST. When UST are plentiful, less privately issued short term debt is supplied.
This is important because they show suggestive evidence that the “quantity of short-term debt issued by the financial sector predicts financial crises better than standard measures such as private credit/GDP.”