The Demand for Short-Term, Safe Assets and Financial Stability : Some Evidence and Implications for Central Bank Policies

A number of researchers have recently argued that the growth of the shadow banking system in the years preceding the recent U.S. financial crisis was driven by rising demand for "money-like" claims — short-term, safe instruments (STSI) — from institutional investors and nonfinancial firms. These instruments carry a money premium that lowers their yields. While government securities are an important part of the supply of STSI, financial intermediaries also take advantage of this money premium when they issue certain types of low-risk, short-term debt, such as asset-backed commercial paper or repo. In this paper, we take the demand for STSI as given and consider the extent to which central banks can improve financial stability and manage maturity transformation by the private sector through their ability to affect the public supply of STSI. The first part of the paper provides new evidence that complements the existing literature on two key ingredients that are necessary for there to be a role for policy: the extent to which public short-term debt and private short-term debt might be substitutes, and the relationship between the money premium and the supply of STSI. The second part of the paper then builds on this evidence and discusses potential ways a central bank could use its balance sheet and monetary policy implementation framework to affect the quantity and mix of short-term liquid assets that will be available to financial market participants