Working Paper

House prices, heterogeneous banks and unconventional monetary policy options

Abstract: This paper develops a nancial mechanism which integrates housing and the real econ- omy through housing-secured debt. In this environment, movements in home prices are ampli ed through both borrowers and banks' balance sheets, leading to a self-reinforcing credit/liquidity crunch. When placed within a traditional business cycle model, this - financial structure quantitatively captures empirical relationships the traditional nancial accelerator mechanism struggles to explain and the qualitative predictions of the model are consistent with dynamic responses from a VAR. The model provides a framework to examine the ability of QE policies and equity injections into big banks to mitigate a housing bust. Although both are e ective, the nuances of the policies are important. A prolonged asset purchase program is preferable to a short-term equity injection; however, the model suggests the equity injections may have been necessary to prevent an economic collapse at the acute stage of the 2008 Financial Crisis.

Keywords: Financial Crises; Financial Frictions; Unconventional Monetary Policy; Housing;

JEL Classification: E32; E44; G01; G21;

Bibliographic Information

Provider: Federal Reserve Bank of Kansas City

Part of Series: Research Working Paper

Publication Date: 2014-10-01

Number: RWP 14-12

Pages: 68 pages