Safe Assets As Commodity Money

This paper presents a model in which safe assets are systemic because they are the medium of exchange for risky assets. It connects the literature from banking and finance on safe assets to the monetary literature on alternative monetary systems involving commodity money, interest bearing money, and private money creation. This connection shows that because safe assets have intrinsic value that is unrelated to their use as a medium of exchange, changes in their supply lead to changes in market efficiency. In addition, because safe assets are costly to produce, there is overproduction of safe assets relative to the socially efficient benchmark. Quantitatively, the welfare consequences of these inefficiencies depend on the costs of producing safe assets, which can be inferred from the equilibrium value of the liquidity premium. When the model is calibrated to plausible liquidity premiums the resulting inefficiencies are not large