Financial Frictions, Durable Goods and Monetary Policy
Ugochi Emenogu and
Leo Michelis ()
Staff Working Papers from Bank of Canada
Financial frictions affect how much consumers spend on durable and non-durable goods. Borrowers can face both loan-to-value (LTV) constraints and payment-to-income (PTI) constraints. In this setting, a monetary contraction drastically reduces the amount consumers can borrow to purchase durable goods. We examine these effects in a dynamic stochastic general equilibrium (DSGE) model. DSGE models with durables predict that when monetary policy tightens, non-durable consumption will fall and durable consumption will rise. But this prediction contradicts empirical evidence, which shows that both types of consumption fall, and durables fall more than non-durables. Studies have tried to resolve this puzzle by integrating LTV constraints into the model, but without much success. In our model, we use a broader set of financial frictions that includes PTI limits on borrowing. We show that using both LTV and PTI constraints in the model solves the counterfactual increase in durables following a contractionary monetary shock and delivers the correct correlation. Including the PTI limit in the model leads to a decrease in labour supply. This reduces output, which, in turn, makes it more likely that total durable expenditures will fall.
Keywords: Financial system regulation and policies; Monetary Policy (search for similar items in EconPapers)
JEL-codes: E44 E52 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-dge, nep-mac, nep-mon and nep-ore
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Persistent link: https://EconPapers.repec.org/RePEc:bca:bocawp:19-31
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