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Leaning against boom–bust cycles in credit and housing prices

  • Lambertini, Luisa
  • Mendicino, Caterina
  • Teresa Punzi, Maria

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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Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 37 (2013)
Issue (Month): 8 ()
Pages: 1500-1522

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Handle: RePEc:eee:dyncon:v:37:y:2013:i:8:p:1500-1522
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