Housing boom-bust cycles and asymmetric macroprudential policy

Abstract

Macroprudential policy is pre-emptive, aimed at preventing crises. An interpretation of this de nition is a policy of tightening credit strongly during the boom phase of a cycle, but potentially unwinding slowly thereafter. Empirical evidence indeed hints at the existence of such asymmetric policy. I use a New Keynesian model with a nancial friction on mortgage borrowing and collateral to show what implications this asymmetry might have on the economy. The main source of uctuations is a bubble in the housing market, which causes house prices and credit to deviate from their fundamental values, leading to a boom and bust cycle. The main macroprudential tool is the regulatory loan to value (LTV) ratio. I nd that while the asymmetric policy dampens the boom phase, it introduces more volatility in the economy by exacerbating the correction that follows. The higher the asymmetry in the policy response, the more volatile the economy is relative to one in which policy reacts symmetrically. Although both savers' and borrowers' consumption become more volatile, that of borrowers is especially sensitive as they are credit constrained and cannot smoothen consumption. Furthermore, the increased in ation volatility can create tensions between the goals of monetary and macroprudential policies. In this regard, policymakers are advised to unwind macroprudential policy just as strongly during the recovery phase of a cycle, such that the economy can exit the recession quicker, and credit, output and inflation are stabilised better.