Optimal Monetary Policy in a Collateralized Economy

45 Pages Posted: 27 Aug 2016

See all articles by Gary B. Gorton

Gary B. Gorton

Yale School of Management; National Bureau of Economic Research (NBER); Yale University - Yale Program on Financial Stability

Ping He

Tsinghua University, SEM

Multiple version iconThere are 2 versions of this paper

Date Written: August 26, 2016

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.

Suggested Citation

Gorton, Gary B. and He, Ping, Optimal Monetary Policy in a Collateralized Economy (August 26, 2016). Available at SSRN: https://ssrn.com/abstract=2830487 or http://dx.doi.org/10.2139/ssrn.2830487

Gary B. Gorton (Contact Author)

Yale School of Management ( email )

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National Bureau of Economic Research (NBER)

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Yale University - Yale Program on Financial Stability

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Ping He

Tsinghua University, SEM ( email )

Beijing, 100084
China
8610-62795754 (Phone)
8610-62784554 (Fax)

HOME PAGE: http://www.sem.tsinghua.edu.cn/en/heping

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