House Price Dynamics, Optimal LTV Limits and the Liquidity Trap

Andrea Ferrero · Richard Harrison · Benjamin D. Nelson

33 citations0/0 files storedThe Review of Economic Studies

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Monetary Policy and Economic Impact Banking stability, regulation, efficiency Economic theories and models

Abstract

Abstract This paper studies the optimal design of a macro-prudential instrument, a loan-to-value (LTV) limit, and its implications for monetary policy in a model with nominal rigidities and financial frictions. The analysis accounts for both an effective lower bound on the nominal interest rate and an upper bound on the ability of LTV limits to stimulate credit demand. The welfare-based loss function features a role for macro-prudential policy to enhance risk-sharing. Optimal LTV limits are strongly countercyclical. In a house price boom-bust episode, the active use of LTV limits alleviates debt-deleveraging dynamics and prevents the economy from falling into a liquidity trap.

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1993Discretion versus policy rules in practice 1983Staggered prices in a utility-maximizing framework 1997Credit Cycles 1999The Science of Monetary Policy: A New Keynesian Perspective 2008Liquidity and leverage 2010A model of unconventional monetary policy 2012Credit Spreads and Business Cycle Fluctuations 2009The Consequences of Mortgage Credit Expansion: Evidence from the U.S. Mortgage Default Crisis *

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