House price dynamics, optimal LTV limits and the liquidity trap

Staff working papers set out research in progress by our staff, with the aim of encouraging comments and debate.
Published on 25 March 2022

Staff Working Paper No. 969

By Andrea Ferrero, Richard Harrison and Benjamin Nelson

The global financial crisis prompted the rapid development of macro-prudential frameworks and an increased reliance on borrower-based policy tools, which influence the demand for credit. This paper studies the optimal design of one such tool, a loan-to-value (LTV) limit, and its implications for monetary policy in a model with nominal rigidities and financial frictions. The welfare-based loss function features a role for macro-prudential policy to enhance risk-sharing. Optimal LTV limits are strongly countercyclical. In a house price boom-bust episode, the active use of LTV limits alleviates debt-deleveraging dynamics and prevents the economy from falling into a liquidity trap.

House price dynamics, optimal LTV limits and the liquidity trap

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