Working Paper: CEPR ID: DP13400
Authors: Andrea Ferrero; Richard Harrison; Benjamin Nelson
Abstract: The inception of macro-prudential policy frameworks in the wake of the global financial crisis raises questions about the effects of the newly available policy tools and their interaction with the existing ones. We study the optimal setting of a loan-to-value (LTV) limit, and its implications for optimal monetary policy, in a model with nominal rigidities and financial frictions. The welfare-based loss function implies a role for macro-prudential policy to enhance risk-sharing. Following a house price boom-bust episode, macro-prudential policy alleviates debt-deleveraging dynamics and prevents the economy from falling into a liquidity trap. In this scenario, optimal policy always entails countercyclical LTV limits, while the response of the nominal interest rate depends on the nature of the underlying shock driving house prices.
Keywords: monetary policy; macroprudential policy; financial crisis; zero lower bound
JEL Codes: E52; E58; G01; G28
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| inactive macroprudential policy (E63) | crises (H12) |
| credit supply shocks (E51) | debt increase (H63) |
| debt increase (H63) | house prices collapse (R31) |
| LTV policies (G52) | recession prevention (E65) |
| LTV adjustments (G51) | borrower behavior (G51) |
| LTV adjustments (G51) | economic stability (E63) |
| LTV limits (G51) | economic outcomes (F61) |
| macroprudential policy (E60) | risk-sharing (D16) |
| LTV limits (G51) | liquidity traps (E41) |
| macroprudential policy (E60) | debt-deleveraging dynamics (F65) |