House Prices, Credit Growth, and Excess Volatility: Implications for Monetary and Macroprudential Policy

Paolo Gelain, Kevin Lansing and Caterina Mendicino

International Journal of Central Banking, 2013, vol. 9, issue 2, 219-276

Abstract: Progress on the question of whether policymakers should respond directly to financial variables requires a realistic economic model that captures the links between asset prices, credit expansion, and real economic activity. Standard DSGE models with fully rational expectations have difficulty producing large swings in house prices and household debt that resemble the patterns observed in many industrial countries over the past decade. We show that the introduction of simple moving-average forecast rules for a subset of agents can significantly magnify the volatility and persistence of house prices and household debt relative to an otherwise similar model with fully rational expectations. We evaluate various policy actions that might be used to dampen the resulting excess volatility, including a direct response to house-price growth or credit growth in the central bank’s interest rate rule, the imposition of a more restrictive loan-to-value ratio, and the use of a modified collateral constraint that takes into account the borrower’s wage income. Of these, we find that a debt-toincome type constraint is the most effective tool for dampening overall excess volatility in the model economy. While an interest rate response to house-price growth or credit growth can stabilize some economic variables, it can significantly magnify the volatility of others, particularly inflation.

JEL-codes: D84 E32 E44 G12 O40 (search for similar items in EconPapers)
Date: 2013
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Citations: View citations in EconPapers (104)

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Related works:
Working Paper: House prices, credit growth, and excess volatility: Implications for monetary and macroprudential policy (2012)
Working Paper: House Prices, Credit Growth, and Excess Volatility: Implications for Monetary and Macroprudential Policy (2012)
Working Paper: House prices, credit growth, and excess volatility: implications for monetary and macroprudential policy (2012)
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Persistent link: https://EconPapers.repec.org/RePEc:ijc:ijcjou:y:2013:q:2:a:11

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