Money and Collateral

• Author: FABRIZIO MATTESINI,LEO FERRARIS
• Published date: 01 October 2020
• Date: 01 October 2020
• DOI: http://doi.org/10.1111/jmcb.12724

DOI: 10.1111/jmcb.12724

LEO FERRARIS

FABRIZIO MATTESINI

Money and Collateral

This paper presents a model in which collateralized monetary loans are es-

sential as trading instruments. Money and private debt collateralized by real

assets complement each other as allocative tools in an environmentwith in-

formational and commitment limitations. Public debt may play a socially

benecial role when collateral is scarce.

JEL codes: E40

Keywords: money, credit, collateral, essentiality

W     to fulll their obli-

gations, they are often required to pledge assets as collateral. The practice of lending

money in an agreement that is secured by assets used as collateral, is widespread 1but

puzzling, as it is unclear why often easily marketable assets are pledged as collateral

to borrow cash, rather than, say,being pledged to borrow directly goods or being used

as payment instruments, or even sold for cash. Lagos (2011) goes as far as to argue

that direct payment with an asset, repos, and collateralized loans are all equivalent:

Once stripped from the subsidiary contractual complexities, the essence of these

transactions is that the asset helps the untrustworthy buyer to obtain what he wants

from the seller (Lagos 2011, p. 521).

This paper shows that there are circumstances in which there is a clear rationale

for using collateralized monetary loans rather than other only seemingly equivalent

arrangements. This requires setting up an environment with money, loans, and real

assets, in which collateralized monetary loans outperform any feasible alternative

Financial support from the Einaudi Institute for Economics and Finance is gratefully acknowledged.

Ferraris acknowledges support from the Montalcini Program of the Italian Government. We thank par-

ticipants at several conferences and seminars, including the 2015 St. Louis Workshop on Money, Credit

and Banking and the 2016 SAET conference in Rio de Janeiro. We thank an editor and two anonymous

referees for their thoughtful comments on the manuscript. Usual disclaimers apply.

L F is an Department of Economics and Finance, Tor Vergata University (E-mail:

leo.ferraris@uniroma2.it). F Mis an Department of Economics and Finance, Tor Vergata

University (E-mail: fabrizio.mattesini@uniroma2.it).

Received April 4, 2018; and accepted in revised form June 25, 2019.

1. According to Azariadis, Kaas, and Wen (2016), about 45% of liabilities of nonnancial U.S. rms

is secured by collateral. The percentage is higher for loans to small businesses and consumers.

Journal of Money, Credit and Banking, Vol. 52, No. 7 (October 2020)

© 2020 The Ohio State University

1618 :MONEY,CREDIT AND BANKING

trading arrangement, being essential to achieve outcomes that could not be obtained

in other ways (see Wallace 2001).

The project is rife with difculties. First, the literature has mostly conceived the

available trading instruments as being in competition for the single role of medium

to exchange goods,2which has lead to focus on real, rather than monetary loans. 3

Second, as seen above, the collateral or direct payment uses of real assets4are often

considered equivalent ways of achieving the same outcomes.5Third, no general joint

essentiality result is available for environments with multiple trading instruments.6

Overall, the lesson one can draw from the existing literature with multiple trading

instruments is that it is hard to distinguish their transaction functions and have

them all simultaneously essential. To overcome the difculties, this paper explores

the idea that the different instruments may actually cooperate to solve an allo-

cation problem which is not just conned to the goods but includes the assets

themselves.

We build a search environment based on Lagos and Wright (2005), in which the

allocative problem, made nontrivial by limited commitment and record keeping (see

Kocherlakota 1998), concerns both the goods and the assets, that may be temporarily

misallocated relative to best use. Two features of the environment give an essential

role to collateralized monetary loans: (i) the specicity of the real assets which are

productive only for some of the agents;7and (ii) the need to allocate all the assets to

the same side of the market. The rst element requires the property rights over real

assets to be assigned correctly, making them better as collateral than direct means

of payment; the second element creates room for the different trading instruments to

cooperate rather than compete as media of trade.

We show that, in this environment, the best way to have both goods and assets

allocated to the agents who most need them, consists in purchasing real assets with

cash, then, pledging the assets to borrow extra cash, and, nally, spend the cash to

buy the goods. This complementary use of money and credit, through collateralized

2. The relevant literature on multiple trading instruments, such as money, credit and real assets, in-

cludes Kocherlakota and Wallace(1998), Corbae and Ritter (2004), and Jin and Temzelides (2004) in in-

divisible money models; Berentsen, Camera, and Waller(2007), Geromichalos, Licari, and Suarez Lledo

(2007), Lagos (2010, 2011), Li and Li (2013), and He, Wright, and Zhu (2015), He, Huang, and Wright

(2005, 2008), Telyukovaand Wright (2008) with divisible money.

3. Exceptions include Shi (1996), Berentsen, Camera, and Waller (2007), Ferraris and Watanabe

(2008), and Ferraris (2010).

4. Ferraris and Watanabe (2008) is an example of the rst approach, Lagos and Rocheteau (2008) of

the second.

5. In a similar vein, Venkateswaranand Wright (2013) write:

While these two ways in which assets may facilitate intertemporal exchange - serving as a medium

of exchange or as collateral - look different on the surface, they are often equivalent(Venkateswaran and

Wright 2013, p. 228).

6. There are both negative and positive results. Whether money and credit can be jointly essential or

not, at this stage, seems to hinge on the possibility to use the interest rate involvedin credit transactions as

a way to reward idle cash. Forinstance, in Gu, Mattesini, and Wright (2016) this is not allowed and money

and credit are not simultaneously essential; while in Araujo and Ferraris (2018), where this is allowed,

they are both essential.

7. This is reminiscent of Kiyotaki and Moore (1997, 2002, 2005).