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Low Real Interest Rates, Collateral Misrepresentation, and Monetary Policy

A model is constructed in which households and banks have incentives to fake the quality of collateral. These incentive problems matter when collateral is scarce in the aggregate – when real interest rates are low. Conventional monetary easing can exacerbate these problems, in that the misrepresentation of collateral becomes more pro…table, thus increasing haircuts and interest rate differentials. Central bank purchases of private mortgages may not be feasible, due to misrepresentation of asset quality. If feasible, central bank asset purchase programs work by circumventing suboptimal fi…scal policy, not by mitigating incentive problems in asset markets. (Previously circulated under the title,"Central Bank Purchases of Private Assets.")

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