Financial System Leverage and the Shortage of Safe Assets: Exploring the Policy Options

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Abstract

In this article, we provide a simple supply and demand framework in which the build-up of an excessive level of leverage can result in a shortage of safe assets. On the basis of this, we discuss various policy options. First, we address the question of what policy-makers should do if shortages of safe assets arise. Second, we discuss what has to be done to prevent potential shortages of safe assets. Our main finding is that a smoother leverage cycle – which, in particular, implies less leverage in booms – is a major condition for preventing shortages of safe assets.

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