This paper reviews the role of collateral constraints in transforming small monetary shocks into large persistent output fluctuations.We do this by introducing money in the heterogeneous-agent real economy of Kiyotaki and Moore (1997). Money enters in a cash-in-advance constraint and money supply is managed via open-market operations.We find that a monetary shock generates persistent movements in aggregate output, the amplitude of which depends upon whether or not debt contracts are indexed. If only nominal contracts are traded, money shocks can trigger large output fluctuations. In this case a money expansion triggers a boom, whereas money contractions generate recessions. In contrast, if contracts are indexed then amplification is not only smaller; it can also generate the reverse results. When the possibility of default and renegotiation is considered, the model can generate asymmetric business cycles with recessions milder than booms. Finally, monetary shocks generate a highly persistent dampening cycle rather than a smoothly declining deviation. (JEL: E32, E43, E44, E52) Copyright (c) 2004 by the European Economic Association.
