Final Report Summary - MACROCOLL (The Macroeconomics of Collateral) The summary should be a stand-alone description of the project and its outcomes. This text should be as concise as possible and suitable for dissemination to non-specialist audiences. Please notice that this summary will be published.My project studied how real-world financial markets rely on different types of backing or collateral to guarantee promises, and how this affects the macroeconomy. A first part of the proposal studies the macroeconomic implications of ‘bubbly’ collateral, which refers to promises that are backed by nothing else but expectations. Such is the case of asset-price bubbles in the housing or stock markets, for instance, where the price of an asset is high today only because it is expected to remain high in the future. Bubbly collateral has important macroeconomic effects but, precisely because it is driven by expectations, it is volatile. My research shows how fiscal and monetary policy can be used to stabilize the value of bubbles and their macroeconomic effects, both in closed economies and in a globalized world of integrated economies. It also uncovers new costs of bubbles that had up to now been unexplored. Namely, since bubbles are driven by expectations and not by economic fundamentals, they reduce the incentives of market participants to acquire information about these fundamentals. In this sense, bubbles “deplete” the information in an economy and can thereby affect the allocation of resources and give rise to deep crises. A second part of the proposal studies governments’ ability to back their own promises (i.e. their ability to issue public debt). Here, the main finding is that the distribution of public debt across different economic agents (for instance, across different banks or across domestic of foreign residents) has important implications for the sustainability of debt and for the macroeconomic effect of fiscal policy. I also show that this distribution is itself endogenous and can change in times of crisis, moreover. Most notably, the “home bias” of public debt increases during crises as debt holdings shift away from foreigners towards domestic residents. This has important macroeconomic effects because it implies that foreign funding dries-up precisely when it is most needed. Finally, a third part of the proposal studies how the effects of credit booms (i.e. large surges in credit) are transmitted to different parts of the economy by the financial system. In particular, I study how housing booms and sovereign-debt inflows are transmitted through domestic banks, with negative (albeit transitory) effects on the non-housing and tradeable sectors, respectively.
