House Prices, Capital Inflows and Macroprudential Policy

Caterina Mendicino, Maria Teresa Punzi

Publication: Working/Discussion PaperWU Working Paper

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Abstract

This paper evaluates the monetary and macroprudential policies that mitigate the procyclicality arising from
the interlinkages between current account deficits and financial vulnerabilities. We develop a two-country
dynamic stochastic general equilibrium (DSGE) model with heterogeneous households and collateralised debt. The model predicts that external shocks are important in driving current account deficits that are coupled with run-ups in house prices and household debt. In this context, optimal policy features an interest-rate response to credit and a LTV ratio that countercyclically responds to house price dynamics. By allowing an interest-rate response to changes in financial variables, the monetary policy authority improves social welfare, because of the large welfare gains accrued to the savers. The additional use of a countercyclical LTV ratio that responds to house prices, increases the ability of borrowers to smooth consumption over the cycle and is Pareto improving. Domestic and foreign shocks account for a similar fraction of the welfare gains delivered by such a policy. (authors' abstract)
Original languageEnglish
Place of PublicationVienna
PublisherWU Vienna University of Economics and Business
DOIs
Publication statusPublished - 1 Aug 2014

Publication series

SeriesDepartment of Economics Working Paper Series
Number180

Bibliographical note

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WU Working Paper Series

  • Department of Economics Working Paper Series

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