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House Price Dynamics, Optimal LTV Limits and the Liquidity Trap

Author

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  • 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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    Cited by:

    1. Mendicino, Caterina & Nikolov, Kalin & Suarez, Javier & Supera, Dominik, 2020. "Bank capital in the short and in the long run," Journal of Monetary Economics, Elsevier, vol. 115(C), pages 64-79.
    2. Zaretski, Aliaksandr, 2021. "Financial constraints, risk sharing, and optimal monetary policy," MPRA Paper 110757, University Library of Munich, Germany.
    3. Igarashi, Yoske & Liu, Keqing, 2024. "Should macroprudential policy be countercyclical?," Journal of Economic Dynamics and Control, Elsevier, vol. 158(C).
    4. Dirma, Mantas & Karmelavičius, Jaunius, 2025. "Micro-assessment of macroprudential borrower-based measures," Journal of Banking & Finance, Elsevier, vol. 176(C).
    5. Tayler, William J. & Zilberman, Roy, 2024. "Unconventional policies in state-dependent liquidity traps," Journal of Economic Dynamics and Control, Elsevier, vol. 168(C).
    6. Marc Hinterschweiger & Kunal Khairnar & Tolga Ozden & Tom Stratton, 2021. "Macroprudential policy interactions in a sectoral DSGE model with staggered interest rates," Bank of England working papers 904, Bank of England.
    7. Yang Zhou & Shigeto Kitano, 2025. "Capital Controls or Macroprudential Policies: Which is Better for Land Booms and Busts?," Open Economies Review, Springer, vol. 36(3), pages 835-871, July.
    8. Stephen Millard & Margarita Rubio & Alexandra Varadi, 2024. "The Macroprudential Toolkit: Effectiveness and Interactions," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 86(2), pages 335-384, April.
    9. Forster, Robert & Sun, Xiaojin, 2022. "Taming the housing crisis: An LTV macroprudential policy," Economic Modelling, Elsevier, vol. 108(C).
    10. Chadha, Jagjit S. & Corrado, Germana & Corrado, Luisa & De Lorenzo Buratta, Ivan, 2026. "The role of macroprudential policy in times of trouble," European Economic Review, Elsevier, vol. 181(C).
    11. 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.
    12. Stephen Millard, & Margarita Rubio & Alexandra Varadi, 2020. "The impact of Covid-19 on productivity," Discussion Papers 2020/14, University of Nottingham, Centre for Finance, Credit and Macroeconomics (CFCM).

    More about this item

    Keywords

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    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • G01 - Financial Economics - - General - - - Financial Crises
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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