House prices, capital inflows and macroprudential policy

Caterina Mendicino and Maria Teresa Punzi

Journal of Banking & Finance, 2014, vol. 49, issue C, 337-355

Abstract: This paper evaluates the monetary and macroprudential policies that mitigate the procyclicality arising from the interlinkages between current account deficits and financial vulnerabilities. We develop a two-country dynamic stochastic general equilibrium (DSGE) model with heterogeneous households and collateralised debt. The model predicts that external shocks are important in driving current account deficits that are coupled with run-ups in house prices and household debt. In this context, optimal policy features an interest-rate response to credit and a LTV ratio that countercyclically responds to house price dynamics. By allowing an interest-rate response to changes in financial variables, the monetary policy authority improves social welfare, because of the large welfare gains accrued to the Savers. The additional use of a countercyclical LTV ratio that responds to house prices, increases the ability of borrowers to smooth consumption over the cycle and is Pareto improving. Domestic and foreign shocks account for a similar fraction of the welfare gains delivered by such a policy.

Keywords: House prices; Financial frictions; Global imbalances; Saving glut; Dynamic loan-to value ratios; Monetary policy; Optimized simple rules (search for similar items in EconPapers)
JEL-codes: C33 E51 F32 G21 (search for similar items in EconPapers)
Date: 2014
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (56)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:49:y:2014:i:c:p:337-355

DOI: 10.1016/j.jbankfin.2014.06.007

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