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Leaning against boom–bust cycles in credit and housing prices

Authors
Journal
Journal of Economic Dynamics and Control
0165-1889
Publisher
Elsevier
Volume
37
Issue
8
Identifiers
DOI: 10.1016/j.jedc.2013.03.008
Keywords
  • Expectation-Driven Cycles
  • Macro-Prudential Policy
  • Monetary Policy
  • Welfare Analysis
Disciplines
  • Economics

Abstract

Abstract This paper studies the potential gains of monetary and macro-prudential policies that lean against house-price and credit cycles. We rely on a model that features Borrowers and Savers and allows for over-borrowing induced by news-shock-driven cycles. We find that policy that responds to changes in financial variables is socially optimal. Considering the use of a single policy instrument, both types of agents are better off when the interest rate optimally responds to credit growth. When we allow for the implementation of both interest-rate and LTV policies, heterogeneity in the welfare implications is key in determining the optimal use of policy instruments. The optimal policy for the Borrowers is characterized by a LTV ratio that responds countercyclically to credit growth, which most effectively stabilizes credit relative to GDP. In contrast, the optimal policy for the Savers features a constant LTV ratio coupled with an interest-rate response to credit growth. News-shock-driven cycles account for most of the gains from a policy response to changes in financial variables.

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