The Global Safe Asset Shortage: Why it Matters for Canada

In the decade leading up to the pandemic, safe assets did not keep pace with global demand. The supply of high-grade government bonds in advanced economies was constrained because budget deficits were declining. At the same time, the demand for these assets increased due to the aging population, more restrictive regulations on financial institutions (requiring them to hold more safe assets) and the rapid growth rates in high-saving emerging markets with underdeveloped financial markets, notably China.<br><br>In our paper, we show this was true in Canada as well. And, despite interest rates on the rise and governments issuing tons of debt during the pandemic, the safe asset shortage is likely not a one-off phenomenon of the years between the Global Financial Crisis (GFC) and the pandemic. It is important, therefore, to have a general understanding of how the shortage might impact economic growth and what drives the scarcity in the first place.<br><br>We investigate whether a shortage of safe assets – both global and domestic – had a negative impact on the Canadian economy and find that it did. This investigation fills an important gap in our knowledge as the vast majority of previous studies on the macroeconomic impact of safe asset shortages have focused on the US. Another novel contribution is we empirically investigate the drivers of country-specific safe asset shortages and discuss policy implications.<br><br>Three key policy implications emerge for Canada. First, it is not viable to increase the supply of Canadian safe assets by increasing Canadian government debt so that it would meet the excess demand for those assets. Although it might help to reduce the shortage of Canadian safe assets in the short-run, it can come at the expense of Canadian output, particularly when the government debt-to-GDP ratio is high.<br><br>Second, loosening domestic regulatory requirements is unlikely to alleviate any shortage of Canadian safe assets. Furthermore, it will likely have no effect at all on the global shortage of safe assets. This is because Canada is a small, open advanced economy, and any action that we take in this regard, if it is to be consequential, must be done in concert with our peers on the international stage.<br><br>Finally, if Canada wants to address its domestic safe asset shortage, it needs to work with other economically significant economies in fora such as the G7, the G20 and the BIS to address the global safe asset shortage. And Canada must do this in tandem not only with other advanced economies, but also with large emerging markets on the demand side. Both the large demanders and large suppliers of safe assets must work together in order to address this global safe asset shortage.