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

Author

Listed:
  • Tatiana Damjanovic

    (Department of Economics, University of Exeter)

  • Sarunas Girdenas

    (Department of Economics, University of Exeter)

Abstract

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.

Suggested Citation

  • Tatiana Damjanovic & Sarunas Girdenas, 2013. "Should Central Bank respond to the Changes in the Loan to Collateral Value Ratio and in the House Prices?," Discussion Papers 1303, Exeter University, Department of Economics.
  • Handle: RePEc:exe:wpaper:1303
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    File URL: http://people.exeter.ac.uk/cc371/RePEc/dpapers/DP1303.pdf
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    References listed on IDEAS

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    More about this item

    Keywords

    optimal monetary policy; money supply; money multiplier; loan to value ratio; collateral constraint; house prices; zero bound interest rate.;

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
    • 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

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