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Collateral Crises

  • Gary Gorton

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

  • Guillermo Ordonez

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

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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File URL: http://www.imes.boj.or.jp/research/papers/english/11-E-25.pdf
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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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