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Collateral Crises

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  • Gary Gorton

    (Yale University and NBER (e-mail: gary.gorton@yale.edu))

  • Guillermo Ordonez

    (Yale University (e-mail: guillermo.ordonez@yale.edu)

Abstract

How can a small shock sometimes cause a large crisis when it does not at other times? Financial fragility builds up over time because it is not optimal to always produce costly information about counterparties. Short-term, collateralized, debt (e.g., demand deposits, money market instruments) -private money- is efficient if agents are willing to lend without producing costly information about the value of the collateral backing the debt. But, when the economy relies on this informationally-insensitive debt, information is not renewed over time, generating a credit boom during which firms with low quality collateral start borrowing. During the credit boom output and consumption go up, but there is increased fragility. A small shock can trigger a large change in the information environment; agents suddenly produce information about all collateral and find that much of the collateral is low quality, leading to a decline in output and consumption. A social planner would produce more information than private agents, but would not always want to eliminate fragility.

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Bibliographic Info

Paper provided by Institute for Monetary and Economic Studies, Bank of Japan in its series IMES Discussion Paper Series with number 11-E-25.

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Date of creation: Sep 2011
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Handle: RePEc:ime:imedps:11-e-25

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  1. Enrique G. Mendoza & Marco E. Terrones, 2008. "An anatomy of credit booms: evidence from macro aggregates and micro data," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 936, Board of Governors of the Federal Reserve System (U.S.).
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  8. David Andolfatto, 2010. "On the social cost of transparency in monetary economies," Working Papers, Federal Reserve Bank of St. Louis 2010-001, Federal Reserve Bank of St. Louis.
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Cited by:
  1. Toni Ahnert & Ali Kakhbod, 2014. "Information, Amplification and Financial Crisis," Working Papers, Bank of Canada 14-30, Bank of Canada.
  2. Manmohan Singh & Peter Stella, 2012. "Money and Collateral," IMF Working Papers, International Monetary Fund 12/95, International Monetary Fund.
  3. Fabrizio Perri & Vincenzo Quadrini, 2011. "International Recessions," IMES Discussion Paper Series, Institute for Monetary and Economic Studies, Bank of Japan 11-E-26, Institute for Monetary and Economic Studies, Bank of Japan.
  4. Farhi, Emmanuel & Tirole, Jean, 2012. "Liquid Bundles," TSE Working Papers, Toulouse School of Economics (TSE) 12-328, Toulouse School of Economics (TSE), revised Oct 2013.
  5. Guillermo Ordonez & Christoph Trebesch & Helios Herrera, 2013. "Political Booms, Financial Crises," 2013 Meeting Papers, Society for Economic Dynamics 224, Society for Economic Dynamics.
  6. Pablo Kurlat & Laura Veldkamp, 2012. "Should We Regulate Financial Information," Working Papers, New York University, Leonard N. Stern School of Business, Department of Economics 12-15, New York University, Leonard N. Stern School of Business, Department of Economics.
  7. Itay Goldstein & Assaf Razin, 2013. "Three Branches of Theories of Financial Crises," NBER Working Papers 18670, National Bureau of Economic Research, Inc.
  8. repec:fip:fedreq:y:2011:i:3q:p:209-254:n:vol.97no.3 is not listed on IDEAS

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