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

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  • Paolo Gelain

    (Norges Bank)

  • Kevin J. Lansing

    (Federal Reserve Bank of San Francisco)

  • Caterina Mendicino

    (Bank of Portugal)

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.

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Bibliographic Info

Article provided by International Journal of Central Banking in its journal International Journal of Central Banking.

Volume (Year): 9 (2013)
Issue (Month): 2 (June)
Pages: 219-276

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Handle: RePEc:ijc:ijcjou:y:2013:q:2:a:11

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  1. House Prices, Credit Growth, and Excess Volatility: Implications for Monetary and Macroprudential Policy
    by Christian Zimmermann in NEP-DGE blog on 2013-01-14 04:51:55
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Cited by:
  1. Leonardo Gambacorta & Federico M Signoretti, 2013. "Should monetary policy lean against the wind? - an analysis based on a DSGE model with banking," BIS Working Papers 418, Bank for International Settlements.
  2. Paolo Gelain & Kevin J. Lansing, 2013. "House prices, expectations, and time-varying fundamentals," Working Paper 2013/05, Norges Bank.
  3. Maria Teresa Punzi & Caterina Mendicino, 2014. "House Prices, Capital Inflows and Macroprudential Policy," Department of Economics Working Papers wuwp180, Vienna University of Economics, Department of Economics.
  4. Fabio Verona & Manuel M. F. Martins & Inês Drumond, 2014. "Financial Shocks and Optimal Monetary Policy Rules," CEF.UP Working Papers 1402, Universidade do Porto, Faculdade de Economia do Porto.
  5. Canuto, Otaviano & Cavallari, Matheus, 2013. "Monetary policy and macroprudential regulation : whither emerging markets," Policy Research Working Paper Series 6310, The World Bank.
  6. Margarita Rubio, 2014. "Macroprudential Policy Implementation in a Heterogeneous Monetary Union," Discussion Papers 2014/03, University of Nottingham, Centre for Finance, Credit and Macroeconomics (CFCM).
  7. Tony Hall & Jan Jacobs & Adrian Pagan, 2013. "Macro-Econometric System Modelling @75," CAMA Working Papers 2013-67, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
  8. Pierre-Richard Agénor & Luiz A. Pereira da Silva, 2013. "Inflation Targeting and Financial Stability: A Perspective from the Developing World," Working Papers Series 324, Central Bank of Brazil, Research Department.
  9. Pei Kuang, 2013. "Imperfect Knowledge About Asset Prices and Credit Cycles," Discussion Papers 13-02r, Department of Economics, University of Birmingham.
  10. Crowe, Christopher & Dell’Ariccia, Giovanni & Igan, Deniz & Rabanal, Pau, 2013. "How to deal with real estate booms: Lessons from country experiences," Journal of Financial Stability, Elsevier, vol. 9(3), pages 300-319.

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