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Article

Collateral and the Efficiency of Monetary Policy

Economic Theory. 2015. Vol. 59. No. 3. P. 579-603.
Peiris U., Vardoulakis A.

This paper argues that in a monetary Real Business Cycle economy where a complete set of nominal contingent claims exist, the requirement to collateralize loans, alone, does not affect the equilibrium allocation when monetary policy is chosen optimally: The Pareto optimal allocation can be supported. A Friedman rule (r = 0), which would be optimal in the absence of collateral constraints, here is not. At the resulting prices, collateral constraints bind and the allocation is inefficient. However, positive interest rates (through an inflation tax on money balances) support the Pareto optimal allocation when the collateral constraint binds. © 2015, © Springer-Verlag Berlin Heidelberg (Outside the USA).