A Global Safe Asset From and For Emerging Economies


Brunnermeier, Markus K., and Lunyang Huang. “A Global Safe Asset From and For Emerging Economies”. Monetary Policy and Financial Stability: Transmission Mechanisms and Policy Implications. Santiago de Chile: Central Bank of Chile, 2019. 111-167. Print.


This paper examines international capital flows induced by flight-to-safety and proposes a new global safe asset. 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 fire-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 flows to flows across two EME asset classes. The two asset classes are the senior and junior bond of tranched portfolio of EME sovereign bonds.

Last updated on 07/26/2019