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House prices, borrowing constraints and monetary policy in the business cycle

  • Matteo Iacoviello

    ()

    (Boston College)

I develop a general equilibrium model with sticky prices, credit constraints, nominal loans and asset (house) prices. Changes in house prices modify agents' borrowing capacity through collateral value; changes in nominal prices affect real repayments through debt deflation. Monetary shocks move asset and nominal prices in the same direction, and are amplified and propagated over time. The "financial accelerator" is not constant across shocks: nominal debt stabilises supply shocks, making the economy less volatile when the central bank controls the interest rate. I discuss the role of equity, debt indexation and household and firm leverage in the propagation mechanism. Finally, I find that monetary policy should not respond to asset prices as a means of reducing output and inflation volatility.

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Paper provided by Boston College Department of Economics in its series Boston College Working Papers in Economics with number 542.

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Length: 47 pages
Date of creation: 01 Oct 2002
Date of revision: 06 Dec 2004
Publication status: forthcoming, American Economic Review, 2005
Handle: RePEc:boc:bocoec:542
Contact details of provider: Postal: Boston College, 140 Commonwealth Avenue, Chestnut Hill MA 02467 USA
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