Corporate Demand for Safe Assets and Government Crowding-In

Abstract

How does government borrowing affect corporate financing and investment? This paper focuses on the role that government debt plays in providing a safe and liquid store of value to the private sector. In the data, I show that firms interact with the market for government debt in two ways: first, by issuing close substitutes in the form of highly-rated short-term debt; second, by holding government securities and close substitutes on their balance sheets as cash. I present and estimate a general equilibrium model where long-lived corporations make endogenous corporate financing and investment decisions. The government affects these decisions through its issuance of safe debt, which trades in a market which is segmented from long-term corporate debt and equity as a result of the precautionary demand of firms for safety and liquidity and the limited ability of private agents to supply these attributes. When government borrowing increases, the model shows that there are two effects: the first is to increase costs of capital, driving investment down. The second is to decrease the costs of precautionary savings, driving investment up. The precautionary savings channel is quantitatively important: estimating the model from data on the panel of public firms from 2000 on, I find the precautionary savings channel dominates the cost of capital channel. The results suggest that since 2000, corporations rely more on the government as a source of safety and liquidity than they compete with it in providing those services to other sectors.