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House Prices, Heterogeneous Banks and Unconventional Monetary Policy Options

Andrew Smith ()

No 201311, WORKING PAPERS SERIES IN THEORETICAL AND APPLIED ECONOMICS from University of Kansas, Department of Economics

Abstract: 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.

Keywords: Financial Crises; Financial Frictions; Housing; Unconventional Monetary Policy (search for similar items in EconPapers)
JEL-codes: E32 E44 G01 G21 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ban, nep-cba, nep-dge, nep-mac and nep-ure
Date: 2013-11
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Working Paper: House prices, heterogeneous banks and unconventional monetary policy options (2014) Downloads
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