Analyzes optimal monetary policy impacts on financial stability through collateral effects.
Collateral plays a real role in an economy. Mortgage-backed and asset-backed securities (MBS/ABS) produced by the private sector are imperfect substitutes for Treasuries as collateral. The ratio of MBS/ABS to Treasuries is positively related to financial fragility because privately-produced collateral is risky. We analyze optimal central bank policy in a dynamic game between the central bank and private agents. In equilibrium, the central bank sometimes optimally triggers recessions to reduce systemic fragility.
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Gorton et al. (2021) studied this question.
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