Working Paper: NBER ID: w22599
Authors: Gary Gorton; Ping He
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.
Keywords: monetary policy; collateral; financial crises; macroprudential policy
JEL Codes: E02; E42; E44; E5; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| high ratio of mortgage-backed securities (MBS) to treasuries (G21) | increased likelihood of financial crisis (F65) |
| central bank actions (E58) | economic conditions (recessions and systemic risk) (E44) |