House Prices, Borrowing Constraints, and Monetary Policy in the Business Cycle

TLDR

The study develops and estimates a monetary business cycle model that incorporates nominal loans and collateral constraints tied to housing values, and evaluates how house prices and debt indexation affect monetary policy trade‑offs. The authors develop and estimate a monetary business cycle model that incorporates nominal loans and collateral constraints linked to housing values. Demand shocks push housing and nominal prices together, amplifying over time; nominal debt dampens supply shocks and stabilizes the economy, while collateral effects strengthen aggregate demand responses to housing price shocks and nominal debt improves output reactions to inflation surprises.

Abstract

I develop and estimate a monetary business cycle model with nominal loans and collateral constraints tied to housing values. Demand shocks move housing and nominal prices in the same direction, and are amplified and propagated over time. The financial accelerator is not uniform: nominal debt dampens supply shocks, stabilizing the economy under interest rate control. Structural estimation supports two key model features: collateral effects dramatically improve the response of aggregate demand to housing price shocks; and nominal debt improves the sluggish response of output to inflation surprises. Finally, policy evaluation considers the role of house prices and debt indexation in affecting monetary policy trade-offs.