The Irrational Fad and Fashion That Is Belief in a Bond Bubble

Ricardo Caballero: There Is No Bond Bubble

Ricardo Caballero says there is no bond bubble because people really really want safe nominal assets and there are not very many of them--so naturally their price is very high:

Economics: No, there is a shortage of safe assets: Ricardo Caballero our guest wrote on Aug 20th 2010, 15:37 GMT:

IT IS not a bubble. It simply reflects a massive shortage of (what are perceived to be) safe assets.

This shortage was present before the crisis, which is largely what led to the securitisation and tranching boom. However, the crisis destroyed the private supply of these assets, and the recent European crisis destroyed part of the public supply of safe assets. Moreover, each of these crashes raised perceived uncertainty and hence the demand for safety, thus the quantity gap keeps growing, and the yield of the few remaining "safe" assets has to implode in order to restore equilibrium.

Whether people should really really want safe nominal assets so much is a question that I think should be answered "no." But high bond prices are not a bubble--not the result of inconsistent expectations that violate transversality conditions. Ricardo is right.