Crowding in stability? Government Debt, Portfolio Choices and the Goldilocks Principle

My thesis aims to investigate the effects of an expansion and contraction of 'safe asset' supply on real and financial variables. To model this interaction between the real and financial side of the economy I will utilise a Stock Flow Consistent (SFC) framework. I aim to show in an economy with strong economic growth but excess savings that the government, with its debt being the benchmark 'safe asset', can issue enough 'safe-assets' to prevent speculative bubbles from forming. Furthermore, when an economy does enter a recession, the government can use this same method to prevent it from worsening. This flips the whole discussion about government debt. Stabilisation policy now becomes how much government debt is required; not how much is too much.

I have chosen to use a SFC framework to analyse the effects of variations in SA supply. Caverzasi and Godin (2015) point to 3 key elements of SFC models: i) consistency of the overall economy, ii) the integration of the real and financial sides of the economy and iii) the construction of the long run as a chain of the short run. All three are appropriate for my thesis as SA issuance will have implications for all sectors of the economy and likely have short and long-run effects. The construction of an accounting framework allows me to model consistent portfolio rebalancing choices and their effects on real variables. Further, the behavioural equations allow me to analyse risk aversion in a different way to the OLG model (Caballero and Farhi, 2018). With the model completed, then various scenarios can be simulated to analyse system-wide dynamics in non-ergodic time- this is exactly what I hope to achieve (Veronese Passarella, 2019)

This thesis will add to the SFC literature in two ways: firstly by conducting an analysis specifically on SA distribution in a SFC framework and second by adding to the emerging literature on empirical SFC models. Much of the SFC literature up to this point has been theoretical, with few attempts made to fit the model to real world data (Zezza and Zezza, 2019). Empirical models, whilst more difficult, can be more useful for policy recommendations and forecasting- "tools for thinking" tailored to the hypothesis in question. My aim to build a SFC model for safe asset portfolio decisions for two economies, the US and Japan, is appropriate because both countries share features that I wish to investigate (high debt stocks), they have a key difference that will provide further insight (variations in location of debt ownership) and flow-of-funds data for both countries are substantive (see https://www.boj.or.jp/en/statistics/sj/index.htm/ ; and https://www.federalreserve.gov/releases/z1/) (Veronese Passarella, 2019). The role of government debt as a SA raises important questions for macroeconomic policy that can be readily incorporated into Post-Keynesian theorising, which I intend to show using SFC modelling.