Multiperiod loans, occasionally binding constraints and monetary policy: a quantitative evaluation

Abstract

We study the implications of multiperiod mortgage loans for monetary policy, considering several realistic modifications-fixed interest rate contracts, a lower bound constraint on newly granted loans, and the possibility of the collateral constraint to become slack-to an otherwise standard DSGE model with housing and financial intermediaries. We estimate the model in its nonlinear form and argue that all these features are important to understand the evolution of mortgage debt during the recent US housing market boom and bust. We show how the nonlinearities associated with the two constraints make the transmission of monetary policy dependent on the housing cycle, with weaker effects observed when house prices are high or start falling sharply. We also find that higher average loan duration makes monetary policy less effective and may lead to asymmetric responses to positive and negative monetary shocks.

Optimal Policy with Occasionally Binding Constraints: Piecewise Linear Solution Methods

“…Note that the overshoot of inflation in Figure4reflects the role of the model dynamics (in particular the lag of the output gap in the Phillips curve) rather than the result of a credible promise to engineer a period of above target inflation.33 The inclusion of multiple constraints can lead to rich and state-dependent dynamic as demonstrated byBluwstein et al (2020) in the case of occasionally binding constraints on leverage and new lending.…”