We study the effects of globalization on risk sharing and welfare. Like the previous literature, we assume that governments cannot commit to enforce the repayment of debts owed by their citizens. Unlike the previous literature, we assume that governments cannot discriminate between domestic and foreign creditors when enforcing debt payments. This creates novel interactions between domestic and international trade in assets. (i) Increases in domestic trade raise the benefits of enforcement and facilitate international trade. In fact, in our set-up, countries can obtain international risk sharing even in the absence of default penalties. (ii) Increases in foreign trade raise the costs of enforcement and hamper domestic trade. As a result, globalization may worsen domestic risk sharing and lower welfare. We show how these effects depend on various characteristics of tradable goods and explore the roles of borrowing limits, debt renegotiations, and trade policy.

What is the role of monetary policy in a bubbly world? To address this question, we study an economy in which financial frictions limit the supply of assets. The ensuing scarcity generates a demand for “unbacked” assets, i.e., assets that are backed only by the expectation of their future value. We consider two types of unbacked assets: bubbles, which are created by the private sector, and money, which is created by the central bank. Bubbles and money share many features, but they also differ in two crucial respects. First, while the rents from the creation of bubbles accrue to entrepreneurs and foster investment, the rents from money creation accrue to the central bank. Second, while bubbles are driven by market psychology, and can rise and fall according to the whims of the market, money is under the control of the central bank. We characterize the optimal monetary policy and show that, through its ability to supply assets, monetary policy plays a key role in the bubbly world. The model sheds light on the recent expansion of central bank liabilities in response to the bursting of bubbles.