Mortgage design under inflation and real wage uncertainty: The use of a dual index instrument

Designing a mortgage system which protects lenders' interests in an inflationary environment and provides continued accessiblity to credit for borrowers has been a challenge during the past decade. Approaches which addressed either the concerns of lenders (through indexation to inflation) or those of some borrowers (through various subsidies) often exclude a majority of borrowers and provide disincentives to lenders. A dual indexed system safeguards the interests of both groups while providing for continued lending activities. The effects of inflation upon lenders are addressed through indexation of payments to prices, while the payments of borrowers are tied to a wage index with any shortfalls in real payments capitalized for later repayment. This paper presents the underlying logic of a simple financial model that can examine dual index instruments and serve as an analytical tool for officials involved in sector planning.