Optimal Monetary Policy in a Collateralized Economy

No 22599, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: In the last forty or so years the U.S. financial system has morphed from a mostly insured retail deposit-based system into a system with significant amounts of wholesale short-term debt that relies on collateral, and in particular Treasuries, which have a convenience yield. In the new economy the quality of collateral matters: when Treasuries are scarce, the private sector produces (imperfect) substitutes, mortgage-backed and asset-backed securities (MBS). When the ratio of MBS to Treasuries is high, a financial crisis is more likely. The central bank’s open market operations affect the quality of collateral because the bank exchanges cash for Treasuries (one kind of money for another). We analyze optimal central bank policy in this context as a dynamic game between the central bank and private agents. In equilibrium, the central bank sometimes optimally triggers recessions to reduce systemic fragility.

JEL-codes: E02 E42 E44 E5 E52 (search for similar items in EconPapers)
Date: 2016-09
New Economics Papers: this item is included in nep-ban, nep-cba, nep-mac, nep-mon and nep-sog
Note: AP CF EFG ME
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Citations: View citations in EconPapers (14)

Published as Gary Gorton & Ping He, 2023. "Optimal monetary policy in a collateralized economy," Economic Theory, vol 75(1), pages 55-89.

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