Collateral constraints in a monetary economy

This paper studies the role of collateral constraints in transforming small monetary shocks into large persistent output fluctuations. 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. We find that a one-time exogenous monetary shock generates persistent movements in aggregate output, whose amplitude depends on whether or not debt contracts are contingent. If contingent contracts cannot be written, money shocks can trigger large output fluctuations. In this case a one time money expansion triggers a boom, while money contractions generate recessions. In contrast, if contracts are contingent amplification is not only smaller, but it can generate the reverse results. When the possibility of default and renegociation is considered, the model can generate asymmetric business cycles with recessions milder than booms. Finally, one-time shocks monetary shocks generate a highly persistent dampening cycle rather than a smoothly declining deviation