Collateral and Monetary Policy

Manmohan Singh

This chapter deals with the relative prices of money and collateral as both contribute towards financial lubrication in the markets. With some central banks now a major player in the collateral markets, the larger the quantitative easing efforts, the longer these central banks will impact the collateral market and associated repo rate. This may have monetary-policy and financial-stability implications, since the repo rates map the financial landscape that straddles the banknon-bank nexus.

Introduction

Collateral is not integrated within the money or monetary-policy textbooks. Undergraduate macroeconomic textbooks still use the IS/LM (standing for investment, saving, liquidity preference and money supply) model as a construct to demonstrate the relationship between interest rates and real output in the goods-and-services market and the money market. In this model (see Figure 4.1), the intersection of the IS and LM curves is where there is simultaneous equilibrium in both markets. In the figure, the horizontal axis represents output, or real GDP, and is labelled Y. The vertical axis represents the real interest rate, i. Since this is a non-dynamic model, there is a one-to-one