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Mortgage Defaults, Expectation-Driven House Prices and Monetary Policy

BEKIROS, Stelios D.; NILAVONGSE, Rachatar; UDDIN, Gazi S.
Authors registered in the RePEc Author Service: Rachatar Nilavongse and Stelios Bekiros

No ECO 2017/09, Economics Working Papers from European University Institute

Abstract: We contribute to the literature on dynamic stochastic general equilibrium models with housing collaterals by including shocks to house price expectations. We incorporate endogenous mortgage defaults which are rarely included in DSGE models with housing collaterals. We show that our theoretical model of mortgage default is consistent with empirical evidence. We use this particular DSGE setup to study the effects of variations in house price expectations on macroeconomic dynamics and their implications for monetary policy. Extensive model simulations show that an increase in expected future house prices leads to a decline in mortgage default rates as well as in interest rates on loans, whereas it leads to an increase in house prices, household debt, bank leverage ratios and economic activity. As opposed to previous studies we find that inflation is low during a house price boom. Finally, we demonstrate that although monetary policy that reacts to household credit growth improves the stability of the real economy and enhances financial stability, yet it jeopardizes price stability.

Keywords: House price expectations; Inflation dynamics; Monetary policy; Mortgage defaults (search for similar items in EconPapers)
JEL-codes: E32 E44 E52 (search for similar items in EconPapers)
Date: 2017
New Economics Papers: this item is included in nep-dge, nep-mac, nep-mon and nep-ure
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