Title: Liquidity, Collateral Constraints, and Interest Rates
Speaker: Zeng Zhixiong, Zhongnan University of Economics and Law.
Host: Tian shu, Associate Professor, RIEM
Time: 14:00-15:30, May 5, Friday
Venue: H501, Liulin Campus
Abstract: We construct a model that integrates entrepreneurial activity and collateral constraints into a search-theoretic framework of money with multiple liquid assets. In the model, interesting-bearing assets coexist with currency as means of payment in decentralized trade. There are banks that play dual roles— providing liquidity insurance and undertaking financial intermediation. Entrepreneurial borrowing from banks is subject to a collateral constraint, which gives rise to imperfections in the credit market. We formulate the optimal monetary policy problem in this environment, highlighting the constraints and tradeoff faced by the policy maker. It is shown that when credit market imperfections are operative, the celebrated Friedman rule is suboptimal. This is because the Friedman rule traps equilibrium real interest rate in its maximum possible value, which is detrimental to entrepreneur’s external financing. The optimal policy implements a non-Friedman rule zero nominal interest rate equilibrium. A critical parameter to our analysis is the haircut on the collateral asset, which represents the severity of financial frictions.