Loan-to-Value Shocks and Macroeconomic Stability

This paper documents the macroeconomic effects of changes in downpayment re- quirements on mortgage loans in a model where investment is undertaken by collateral- constrained agents. I find that a permanent tightening in lending standards substan- tially lowers aggregate spending in the short run and permanently lowers house prices. These effects are much larger than in earlier findings from a model where unconstrained agents invest. Furthermore, I document that the amplification of macroeconomic shocks is much stronger when steady-state loan-to-value ratios are high. The loan-to-value shock itself is amplified to a greater extent when the loan-to-value ratio starts out at a higher level. In that sense, the effects of loan-to-value ratios on the economy are non-linear.

Keywords: Collateral effect; financial accelerator
JEL codes D11; D50; D52; E21

Working paper no. 763