This paper offers an explanation for the interest-rate conundrum and global imbalances, a shortage of financial assets relative to asset demand:
On the Macroeconomics of Asset Shortages, by Ricardo J. Caballero NBER WP 12753, December 2006 [Open link, PowerPoint]: 1 Introduction The world has a shortage of financial assets. Asset supply is having a hard time keeping up with the global demand for store of value and collateral by households, corporations, governments, insurance companies, and financial intermediaries more broadly. In equilibrium, the value of the (relatively) few existing assets must rise, which has important global macroeconomic implications.
These shortages have been a perennial problem in emerging markets, where many of their economic perils and idiosyncrasies stem from this feature.
But we are now seeing a shortage on a global scale. It probably began with the meltdown of a substantial share of Japanese assets in the early 1990s, it was exacerbated by European stagnation and the collective emerging market crises of the late 1990s, and it consolidated in the new millennium by the fast income growth of China and commodity countries, most of which have substantial asset demand needs but are not natural asset producers.
In addition to these macroeconomic factors, there are microeconomic factors contributing to these shortages. In particular, the recent rapid pace of financial development has facilitated restructuring, innovation and economic growth, but because of their margin requirements they may well have been a net collateral consuming activity, at least in the short run.
The equilibrium response of asset prices and valuations to these shortages has played a central role in global economic developments over the last twenty years. The so-called “global imbalances,” the recurrent emergence of speculative bubbles (which recently have transited from emerging markets, to the dot-coms, to real estate, to gold...), the historically low real interest rates and associated “interest-rate conundrum,” and even the widespread low inflation environment and deflationary episodes in parts of the world, all fall into place once one adopts this asset shortage perspective.
Understanding the source of these developments as asset supply shortages informs optimal policy responses. The policy prescriptions that follow from this view are a mixture of conventional advice, with an emphasis on financial development and incentive preservation in capital markets, and more adventurous recommendations. In particular, since speculative bubbles are a necessary evil in this environment, it is important to learn to manage their risks rather than to obsess over choking them. By extension, the same recommendations apply to concerns about global imbalances and over the excess-liquidity consequences of low interest rate policies.
In these notes I sketch the essence of this view and of the main policy recommendations that follow from it. However, these are largely uncharted waters. My discussion has plenty of conjectures anchored by spotty academic work. Much of the research needed to understand what got us to this point, how to manage a global economy of this nature, and ultimately how to grow out it, if this is perceived to be necessary, lies ahead.
5 Final remarks
In these notes I have argued that many of the main macroeconomic events of the last two decades, both for developing and developed economies, can be understood by recognizing a powerful, yet largely ignored ingredient in the analysis of these events: the world seems to have a severe shortage of assets.
This ingredient has positive and normative implications. Among the former, emerging market boom-bust cycles, global imbalances, low real interest rates, deflationary episodes, recurrent bubbles, and financial panics, all follow naturally from this view.
As for policy, perhaps the main advice is the importance of recognizing the source of these symptoms and the fact that some of them are simply the market’s attempt to fill the asset gap. In this context, knee-jerk reactions to the emergence of speculative bubbles and global imbalances can be counterproductive.