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House prices, lending standards, and the macroeconomy

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  • Silvo, Aino

Abstract

I study the link between house prices, lending standards, and aggregate over-investment in housing. I develop a model of the housing market where the credit market is affected by asymmetric information. Selection is towards less creditworthy borrowers. Asymmetric information coupled with deadweight costs of default can create endogenous boom-bust cycles in house prices. I show that lending standards are loose and the incentives for less-than-creditworthy borrowers to apply for a loan are particularly strong, first, when future house values are expected to be high, which leads to high leverage of borrowers; and second, when safe interest rates are low, which implies low costs of borrowing. However, there are strong nonlinearities in the relationship between borrowing incentives and economic fundamentals. The results shed light on incentive mechanisms that can help explain the developments in the U.S. housing market in the early 2000s. They also imply that loose monetary policy can have a direct impact on the stability of the housing market through the cost of borrowing and the opportunity cost of housing investment.

Suggested Citation

  • Silvo, Aino, 2017. "House prices, lending standards, and the macroeconomy," Research Discussion Papers 4/2017, Bank of Finland.
  • Handle: RePEc:bof:bofrdp:2017_004
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    Cited by:

    1. Miettinen, Paavo, 2017. "Information acquisition during a descending price auction with asymmetrically informed players," Research Discussion Papers 5/2017, Bank of Finland.
    2. Tuomas Takalo, 2019. "Regulation of short-term consumer credits," Journal of Banking Regulation, Palgrave Macmillan, vol. 20(4), pages 348-354, December.
    3. Silvo, Aino, 2017. "House prices, lending standards, and the macroeconomy," Research Discussion Papers 4/2017, Bank of Finland.

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    More about this item

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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