Abstract
Collateral plays a real role in an economy. Mortgage-backed and asset-backed securities (MBS/ABS) produced by the private sector are imperfect substitutes for Treasuries as collateral. The ratio of MBS/ABS to Treasuries is positively related to financial fragility because privately-produced collateral is risky. We analyze optimal central bank policy in a dynamic game between the central bank and private agents. In equilibrium, the central bank sometimes optimally triggers recessions to reduce systemic fragility.
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Thanks to an anonymous referee, Javier Bianchi, Hal Cole, Zhiguo He, Sebastian Infante, Todd Keister, Rich Kihlstrom, Ed Nosal, Eric Rosengren, participants at the Monetary Policy Implementation and Transmission in the Post-Crisis Period Conference of the Federal Reserve Board, participants at the Chicago Fed Day-Ahead Conference, and to seminar participants at Tsinghua University, University of Pennsylvania, the Bank for International Settlements and Ohio State University.
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Gorton, G., He, P. Optimal monetary policy in a collateralized economy. Econ Theory 75, 55–89 (2023). https://doi.org/10.1007/s00199-021-01390-5
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DOI: https://doi.org/10.1007/s00199-021-01390-5