Banking competition, housing prices and macroeconomic stability

Javier Andrés () and Óscar Arce ()
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Óscar Arce: Banco de España

No 830, Banco de España Working Papers from Banco de España

Abstract: We develop a dynamic general equilibrium model with an imperfectly competitive bank-loans market and collateral constraints that tie investors credit capacity to the value of their real estate holdings. Banks set optimal lending rates taking into account the effects of their price policies on their market share and on the volume of funds demanded by each customer. Lending margins have a significant effect on aggregate variables. Over the long run, fostering banking competition increases total consumption and output by triggering a reallocation of available collateral towards investors. However, as regards the short-run dynamics, we find that most macroeconomic variables are more responsive to exogenous shocks in an environment of highly competitive banks. Key to this last result is the reaction of housing prices and their effect on borrowers' net worth. The response of housing prices is more pronounced when competition among banks is stronger, thus making borrowers' net worth more vulnerable to adverse shocks and, specially, to monetary contractions. Thus, regarding changes in the degree of banking competition, the model generates a trade-off between the long run level of economic activity and its stability at the business cycle frequency.

Keywords: banking competition; collateral constraints; housing prices (search for similar items in EconPapers)
JEL-codes: E32 E43 E44 G21 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ban, nep-bec, nep-com, nep-dge, nep-mac and nep-ure
Date: Written
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Persistent link: http://EconPapers.repec.org/RePEc:bde:wpaper:0830

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