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House Prices, Heterogeneous Banks and Unconventional Monetary Policy Options

  • Andrew Lee Smith

    (Department of Economics, The University of Kansas)

Bank regulators acknowledge that large U.S. commercial banks allocate considerably more resources to originating and trading off-balance sheet assets than their smaller counter parts. In this paper: (i) I show the asset concentration in these large banks moves closely with home prices due to the collateralized nature of off-balance sheet assets. (ii) I then develop a general equilibrium capable of capturing this asset redistribution between heterogeneous banks. When home prices fall, endogenously tightening leverage constraints force the big productive banks to unload real-estate secured debt to small unproductive banks. The redistribution to less productive banks sets off an asset price spiral in the model - amplifying typical downturns into deep recessions. The model has predictions for the joint behavior of finance premiums, output, home prices and the share of assets held by large banks. (iii) I use a VAR to confirm the model's predictions for these variables are consistent with the data. (iv) Finally, I use this empirically verified model to examine the effectiveness of unconventional monetary policyin mitigating a recession generated by a drop in housing demand. Despite the fact that both equity injections into "Too Big to Fail" banks and asset purchases by the Fed such as "QE 1/2/3" mitigate the crisis, the nuances of the policies are important. A prolonged asset purchase program is preferable to a short-term equity injection.

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File URL: http://www2.ku.edu/~kuwpaper/2013Papers/201311.pdf
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Paper provided by University of Kansas, Department of Economics in its series WORKING PAPERS SERIES IN THEORETICAL AND APPLIED ECONOMICS with number 201311.

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Length: 47 pages
Date of creation: Nov 2013
Date of revision:
Handle: RePEc:kan:wpaper:201311
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  1. Kydland, Finn E & Prescott, Edward C, 1982. "Time to Build and Aggregate Fluctuations," Econometrica, Econometric Society, vol. 50(6), pages 1345-70, November.
  2. Matteo Iacoviello & Stefano Neri, 2010. "Housing Market Spillovers: Evidence from an Estimated DSGE Model," American Economic Journal: Macroeconomics, American Economic Association, vol. 2(2), pages 125-64, April.
  3. Carlstrom, Charles T. & Fuerst, Timothy S. & Ortiz, Alberto & Paustian, Matthias, 2014. "Estimating contract indexation in a Financial Accelerator Model," Journal of Economic Dynamics and Control, Elsevier, vol. 46(C), pages 130-149.
  4. Peter Breuer, 2000. "Measuring off-Balance-Sheet Leverage," IMF Working Papers 00/202, International Monetary Fund.
  5. David C. Wheelock & Paul W. Wilson, 2012. "Do Large Banks Have Lower Costs? New Estimates of Returns to Scale for U.S. Banks," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 44(1), pages 171-199, 02.
  6. Michael D. Bauer & Glenn D. Rudebusch, 2014. "The Signaling Channel for Federal Reserve Bond Purchases," International Journal of Central Banking, International Journal of Central Banking, vol. 10(3), pages 233-289, September.
  7. Townsend, Robert M., 1979. "Optimal contracts and competitive markets with costly state verification," Journal of Economic Theory, Elsevier, vol. 21(2), pages 265-293, October.
  8. Yuriy Gorodnichenko, 2005. "Reduced-Rank Identification of Structural Shocks in VARs," Macroeconomics 0512011, EconWPA.
  9. Nicholas Oulton & Ana Rincon-Aznar, 2009. "Rates of return and alternative measures of capital input: 14 countries and 10 branches, 1971-2005," LSE Research Online Documents on Economics 28687, London School of Economics and Political Science, LSE Library.
  10. Markus K. Brunnermeier, 2009. "Deciphering the Liquidity and Credit Crunch 2007-2008," Journal of Economic Perspectives, American Economic Association, vol. 23(1), pages 77-100, Winter.
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