Discussion paper

DP12024 Systematic Monetary Policy and the Macroeconomic Effects of Shifts in Loan-to-Value Ratios

What are the macroeconomic consequences of changing aggregate lending
standards in residential mortgage markets, as measured by loan-to-value
(LTV) ratios? In a structural VAR, GDP and business investment increase following
an expansionary LTV shock. Residential investment, by contrast, falls,
a result that depends on the systematic reaction of monetary policy. We show
that, historically, the Fed tended to respond directly to expansionary LTV
shocks by raising the monetary policy instrument, and, as a result, mortgage
rates increase and residential investment declines. The monetary policy reaction
function in the US appears to include lending standards in residential
markets, a finding we confirm in Taylor rule estimations. Without the endogenous
monetary policy reaction residential investment increases. House
prices and household (mortgage) debt behave in a similar way. This suggests
that an exogenous loosening of LTV ratios is unlikely to explain booms in
residential investment and house prices, or run ups in household leverage, at
least in times of conventional monetary policy.

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Citation

Bachmann, R (2017), “DP12024 Systematic Monetary Policy and the Macroeconomic Effects of Shifts in Loan-to-Value Ratios”, CEPR Press Discussion Paper No. 12024. https://cepr.org/publications/dp12024