House prices, borrowing constraints and monetary policy in the business cycle

Matteo Iacoviello ()

No 542, Boston College Working Papers in Economics from Boston College Department of Economics

Abstract: I develop a general equilibrium model with sticky prices, credit constraints, nominal loans and asset (house) prices. Changes in house prices modify agents' borrowing capacity through collateral value; changes in nominal prices affect real repayments through debt deflation. Monetary shocks move asset and nominal prices in the same direction, and are amplified and propagated over time. The "financial accelerator" is not constant across shocks: nominal debt stabilises supply shocks, making the economy less volatile when the central bank controls the interest rate. I discuss the role of equity, debt indexation and household and firm leverage in the propagation mechanism. Finally, I find that monetary policy should not respond to asset prices as a means of reducing output and inflation volatility.

Keywords: house prices; collateral effects; nominal debt; monetary policy. Classificaiton - JEL:E31; E32; E44; E52; R21 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-dge and nep-ure
Date: 2002-10-01, Revised 2004-12-06
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Forthcoming, American Economic Review, 2005

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Related works:
Journal Article: House Prices, Borrowing Constraints, and Monetary Policy in the Business Cycle (2005)
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