Collateral Crises

Gary Gorton and Guillermo Ordonez

No 11-E-25, IMES Discussion Paper Series from Institute for Monetary and Economic Studies, Bank of Japan

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.

Date: 2011-09
New Economics Papers: this item is included in nep-ban, nep-cba and nep-cta
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Citations: View citations in EconPapers (3)

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Related works:
Journal Article: Collateral Crises (2014)
Working Paper: Collateral Crises (2012)
Working Paper: Collateral Crises (2011)
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Persistent link: https://EconPapers.repec.org/RePEc:ime:imedps:11-e-25

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