Taming the Housing Crisis : An LTV Macroprudential Policy

This paper develops a DSGE framework featuring a heterogeneous housing market, endogenousdefault, and a banking sector. We find that the idiosyncratic mortgage risk shock plays an importantrole in explaining the fluctuations of house prices during the mid-1980s and the years leading up tothe financial crisis. The same shock is also one of the main driving forces of household loans. Byplacing an occasionally binding constraint on the loan-to-value ratio, we find that the overheatingof the housing economy in the early 2000s and the subsequent crash could have been alleviated, ifauthorities had adopted such a macroprudential policy measure. A welfare comparison indicatesthat the maximum loan-to-value policy is preferable over an augmented Taylor rule that respondsto house price growth