In a monetary union, the risk-free rate cannot respond to country-level fiscal positions, leaving only default spreads and convenience yields to respond. Empirically, we find that convenience yields explain a large share of the variation in Eurozone sovereign bond yields. Eurozone countries earn larger convenience yields when they experience larger surpluses, suggesting convenience yields are important fiscal shock absorbers.
We use discounted cash flow analysis to measure the projected fiscal capacity of the U.S. federal government. We apply our valuation method to the CBO’s projections for the U.S. federal government’s primary deficits between 2022 and 2052 and projected debt outstanding in 2052. The discount rate for projected cash flows and future debt must include a GDP or market risk premium in recognition of the risk associated with future surpluses. Despite current low interest rates, we find that U.S. fiscal capacity is more limited than commonly thought.
Bank balance sheet lending is commonly viewed as the predominant form of lending. We document and study two margins of adjustment that are usually absent from this view using microdata in the $10 trillion U.S. residential mortgage market. We first document the limits of the shadow bank substitution margin: shadow banks substitute for traditional “deposit-taking” banks in loans which are easily sold, but are limited from activities requiring on-balance-sheet financing.