Working Paper: NBER ID: w17771
Authors: Gary B. Gorton; Guillermo Ordonez
Abstract: Short-term collateralized debt, such as demand deposits and money market instruments - private money, is efficient if agents are willing to lend without producing costly information about the collateral backing the debt. When the economy relies on such informationally-insensitive debt, firms with low quality collateral can borrow, generating a credit boom and an increase in output and consumption. Financial fragility builds up over time as information about counterparties decays. A crisis occurs when a small shock then causes a large change in the information environment. Agents suddenly have incentives to produce information, asymmetric information becomes a threat and there is a decline in output and consumption. A social planner would produce more information than private agents, but would not always want to eliminate fragility.
Keywords: financial crises; collateralized debt; credit booms; information production
JEL Codes: E20; E32; E44; G01; G20
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| informationally insensitive debt (F34) | credit boom (F65) |
| credit boom (F65) | increased output and consumption (E20) |
| decay of information about collateral (G33) | small shock leads to systemic crisis (F65) |
| small shock (Y60) | information production about collateral quality (G33) |
| information production about collateral quality (G33) | decline in output (E23) |
| duration of informationally insensitive debt (G33) | size of the downturn (E32) |