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Leaning Against Boom-Bust Cycles in Credit and Housing Prices

  • Luisa Lambertini
  • Caterina Mendicino
  • Maria Tereza Punzi

This paper studies the potential gains of monetary and macro-prudential policies that lean against news-driven boom-bust cycles in housing prices and credit generated by expectations of future macroeconomic developments. First, we find no trade-off between the traditional goals of monetary policy and leaning against boom-bust cycles. An interest-rate rule that completely stabilizes inflation is not optimal. In contrast, an interest-rate rule that responds to financial variables mitigates macroeconomic and financial cycles and is welfare improving relative to the estimated rule. Second, counter-cyclical Loan-to-Value rules that respond to credit growth do not increase inflation volatility and are more effective in maintaining a stable provision of financial intermediation than interest-rate rules that respond to financial variables. Heterogeneity in the welfare implications for borrowers and savers make it difficult to rank the two policy frameworks.

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Paper provided by Banco de Portugal, Economics and Research Department in its series Working Papers with number w201108.

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Date of creation: 2011
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Handle: RePEc:ptu:wpaper:w201108
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