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Should Central Bank respond to the Changes in the Loan to Collateral Value Ratio and in the House Prices?

  • Tatiana Damjanovic

    (Department of Economics, University of Exeter)

  • Sarunas Girdenas

    (Department of Economics, University of Exeter)

We study optimal policy in a New Keynesian model at zero bound interest rate where households use cash alongside with house equity borrowing to conduct transactions. The amount of borrowing is limited by a collateral constraint. When either the loan to value ratio declines or house prices fall we observe decrease in the money multiplier. We argue that the central bank should respond to the fall in the money multiplier and therefore to the reduction in house prices or in the loan to collateral value ratio. We also find that optimal monetary policy generates large and more persistent fall in the money multiplier in response to drop in the loan to collateral value ratio.

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File URL: http://people.exeter.ac.uk/cc371/RePEc/dpapers/DP1303.pdf
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Paper provided by Exeter University, Department of Economics in its series Discussion Papers with number 1303.

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Date of creation: 2013
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Handle: RePEc:exe:wpaper:1303
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