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House Price Dynamics, Optimal LTV Limits and the Liquidity Trap

Author

Listed:
  • Andrea Ferrero
  • Richard Harrison
  • Benjamin Nelson

Abstract

This paper studies the optimal design of a macro-prudential instrument, a loan-to-value (LTV) limit, and its implications for monetary policy in a model with nominal rigidities and financial frictions. The analysis accounts for both an effective lower bound on the nominal interest rate and an upper bound on the ability of LTV limits to stimulate credit demand. The welfare-based loss function features a role for macro-prudential policy to enhance risk-sharing. Optimal LTV limits are strongly countercyclical. In a house price boom-bust episode, the active use of LTV limits alleviates debt-deleveraging dynamics and prevents the economy from falling into a liquidity trap.

Suggested Citation

  • Andrea Ferrero & Richard Harrison & Benjamin Nelson, 2024. "House Price Dynamics, Optimal LTV Limits and the Liquidity Trap," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 91(2), pages 940-971.
    • Handle: RePEc:oup:restud:v:91:y:2024:i:2:p:940-971.
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    File URL: http://hdl.handle.net/10.1093/restud/rdad040
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