Collateral Constraints in a Monetary Economy
The purpose of this paper is to analyze the role of collateral constraints as a transmission mechanism of monetary shocks. We do this by introducing money in the heterogeneous-agent real economy of Kiyotaki and Moore (1997). Money enters in a cash-in-advance constraint and is injected via open-market operations. In the model, a one-time exogenous monetary shock generates persistent movements in aggregate output, whose amplitude depends on the degree of debt indexation. Monetary expansions can trigger a large upward movement in output, while monetary contractions give rise to a smaller downward movement. This asymmetry occurs because full indexation of debt contracts can only be effective following a monetary contraction. In contrast, following a monetary expansion indexation can only be partial because debtors end up paying back just the market value of the collateral. Due to the existence of both cash-in-advance and collateral constraints, monetary shocks generate a highly persistent dampening cycle rather than a smoothly declining deviation.
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