Safe Assets, Credit Provision and Debt Management

This paper analyses the interactions between the financial and the real sector in an environment where liquidity holdings is an input of the credit/investment process. The supply of liquidity is constrained in that income pledgeability limits inside liquidity, and there is a range of outside liquidity instruments that differ for safety and liquidity.We analyse the resulting equilibrium asset prices, collateral/liquidity-safety premia, liquidity instrument holdings and real investment. The model is applied to examine the implications of liquidity provision policies and debt management in the Euro Area.We analyse how the correlation structure of the bond market values affects the optimal composition of liquidity instrument holdings and prices, and formalize the concept of a European Safe Bond with a clear analysis of its potential advantages.