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on Central Banking |
| By: | Tatar, Balint; Wieland, Volker |
| Abstract: | This paper investigates the implications of monetary policy rules during the surge and subsequent decline of inflation in the euro area and compares them to the interest rate decisions of the European Central Bank (ECB). It focuses on versions of the Taylor (1993) and Orphanides and Wieland (OW) (2013) rules. Rules that respond to recent outcomes of HICP Core or domestic inflation data called for raising interest rates in 2021 and well ahead of the rate increases implemented by the ECB. Thus, such simple outcome-based policy rules deserve more attention in the ECB's monetary policy strategy. Interestingly, the rules support the recent shift of the ECB to policy easing. Yet, they add a note of caution by suggesting that policy rates should not decline as fast as apparently anticipated by traded derivative-based interest rate forecasts. |
| Keywords: | Monetary policy, interest rates, European Central Bank, Taylor rule, OrphanidesWieland rule, New Keynesian macro-epidemic models |
| JEL: | E42 E43 E52 |
| Date: | 2024 |
| URL: | https://d.repec.org/n?u=RePEc:zbw:imfswp:303512 |
| By: | Rafael S. M. Ribeiro; Gilberto Tadeu Lima; Gustavo Pereira Serra; Marina Sanches |
| Abstract: | This article examines the impact of restrictive monetary policy, specifically an increase in the benchmark interest rate (Selic), on inflation rates across different consumption groups in Brazil, as measured by the Extended National Consumer Price Index (IPCA). The Central Bank of Brazil uses the Selic rate to align inflation with its target. The study uses the Local Projections model on data from January 2007 to December 2023 to analyze how inflation in various groups and subgroups responds to changes in the Selic rate. Findings indicate that an increase in the Selic rate reduces inflation in groups like “Food and beverages†, “Household items†, and “Clothing†, but has little effect on “Housing†and “Communication†. This research highlights the need for tailored economic policies for different consumption segments, illustrated by a case during the COVID-19 pandemic. |
| Keywords: | Monetary policy; Selic rate; disaggregated inflation; Local Projections model |
| JEL: | E52 E31 C32 E58 |
| Date: | 2024–10–21 |
| URL: | https://d.repec.org/n?u=RePEc:spa:wpaper:2024wpecon24 |
| By: | Groiss, Martin |
| JEL: | C43 E24 E32 E52 |
| Date: | 2024 |
| URL: | https://d.repec.org/n?u=RePEc:zbw:vfsc24:302346 |
| By: | Emter, Lorenz; Setzer, Ralph; Zorell, Nico; Moura, Afonso S. |
| Abstract: | This paper analyses how country-specific institutional quality shapes the impact of monetary policy on downside risks to GDP growth in the euro area. Using identified high-frequency shocks in a growth-at-risk framework, we show that monetary policy has a higher impact on downside risks in the short term than in the medium term. However, this result for the euro area average hides significant heterogeneity across countries. In economies with weak institutional quality, medium-term growth risks increase substantially following contractionary monetary policy shocks. In contrast, these risks remain relatively stable in countries with high institutional quality. This suggests that improvements in institutional quality could significantly enhance euro area countries’ economic resilience and support the smooth transmission of monetary policy. JEL Classification: C23, E52, F45, G28, O43 |
| Keywords: | Euro area, growth-at-risk, institutional quality, monetary policy transmission |
| Date: | 2024–10 |
| URL: | https://d.repec.org/n?u=RePEc:ecb:ecbwps:20242989 |
| By: | Thiago Revil T. Ferreira; Nils M. Gornemann; Julio L. Ortiz |
| Abstract: | Household savings rose above trend in many developed countries after the onset of COVID-19. Given its link to aggregate consumption, the presence of these "excess savings" has raised questions about their implications for the transmission of monetary policy. Using a panel of euro-area economies and high-frequency monetary policy shocks, we document that household excess savings dampen the effects of monetary policy on economic activity and inflation, especially during the pandemic period. To rationalize our empirical findings, we build a New Keynesian model in which households use savings to self-insure against counter-cyclical unemployment and consumption risk. |
| Keywords: | Monetary Policy; Excess Savings; Precautionary Savings; Consumption Risk; Unemployment |
| JEL: | E12 E21 E24 E31 E52 |
| Date: | 2024–10–10 |
| URL: | https://d.repec.org/n?u=RePEc:fip:fedgif:1397 |
| By: | Knapp, Fabian |
| JEL: | D62 E32 E44 F32 F41 |
| Date: | 2024 |
| URL: | https://d.repec.org/n?u=RePEc:zbw:vfsc24:302415 |
| By: | C, Prasanth; Chakraborty, Lekha; K Shihab, Nehla |
| Abstract: | Against the backdrop of the new Monetary Policy Committee (MPC) decisions to maintain the status quo policy rates, we analyse the post-pandemic monetary policy stance in India. Using high-frequency data, the term structure of interest rate is analyzed incorporating monetary aggregates, fiscal deficit, inflation expectations and capital flows. The results revealed that the fiscal deficit does not significantly determine interest rates in the post-pandemic monetary policy stance in India. The long-term interest rates were strongly influenced by the short-term interest rates, which reinforces that term structure is operating in India. The results further revealed that long-term interest rates were also positively influenced by capital flows, and inflation expectations, while it was inversely impacted by the money supply. These inferences have policy implications on the fiscal and monetary policy coordination in India, where it is crucial to analyse the efficacy of high interest rate regime on public debt management. Our results also refute the popular belief that deficits determine interest rates in the context of emerging economies. |
| Keywords: | Interest Rate Determination, Post Pandemic Monetary Policy, Fiscal Deficit, Monetary Policy Commitee |
| JEL: | C32 E43 E63 |
| Date: | 2024–10–10 |
| URL: | https://d.repec.org/n?u=RePEc:pra:mprapa:122345 |
| By: | Gara Afonso; Domenico Giannone; Gabriele La Spada; John C. Williams |
| Abstract: | As central banks shrink their balance sheets to restore price stability and phase out expansionary programs, gauging the ampleness of reserves has become a central topic to policymakers and academics alike. The reason is that the ampleness of reserves informs when to slow and then stop quantitative tightening (QT). The Federal Reserve, for example, implements monetary policy in a regime of ample reserves, whereby the quantity of reserves in the banking system needs to be large enough such that everyday changes in reserves do not cause large variations in short-term rates. The goal is therefore to implement QT while ensuring that reserves remain sufficiently ample. In this post, we review how to gauge the ampleness of reserves using the new Reserve Demand Elasticity (RDE) measure, which will be published monthly on the public website of the Federal Reserve Bank of New York as a standalone product. |
| Keywords: | ample reserves; monetary policy; implementation |
| JEL: | E41 E52 |
| Date: | 2024–10–17 |
| URL: | https://d.repec.org/n?u=RePEc:fip:fednls:98984 |
| By: | Hie Joo Ahn; Leland E. Farmer |
| Abstract: | We develop a model of the individual term structure of inflation expectations across forecasting horizons. Using the Survey of Professional Forecasters, we decompose disagreement about inflation expectations into individuals' long-term beliefs, private information, and public information. We find that in normal times, long-horizon disagreement is predominantly driven by individuals' long-term beliefs, while short-horizon disagreement stems from private information. During economic downturns, heterogeneous reactions to public information become a key driver of disagreement at all horizons. When forecasters disagree about public information, monetary policy exhibits a delayed response and a price puzzle emerges, underscoring the importance of anchoring inflation expectations. |
| Keywords: | Inflation Expectations; Term Structure; Disagreement; Monetary Policy |
| JEL: | E17 E31 E37 E52 E58 E65 |
| Date: | 2024–09–27 |
| URL: | https://d.repec.org/n?u=RePEc:fip:fedgfe:2024-84 |
| By: | Prasanth C. (National Institute of Public Finance and Policy); Chakraborty, Lekha (National Institute of Public Finance and Policy); Shihab, Nehla K. (National Institute of Public Finance and Policy) |
| Abstract: | Against the backdrop of the new Monetary Policy Committee (MPC) decisions to maintain the status quo policy rates, we analyse the post-pandemic monetary policy stance in India. Using high-frequency data, the term structure of interest rate is analyzed incorporating monetary aggregates, fiscal deficit, inflation expectations and capital flows. The results revealed that the fiscal deficit does not significantly determine interest rates in the post-pandemic monetary policy stance in India. The long-term interest rates were strongly influenced by the short-term interest rates, which reinforces that term structure is operating in India. The results further revealed that long-term interest rates were also positively influenced by capital flows, and inflation expectations, while it was inversely impacted by the money supply. These inferences have policy implications on the fiscal and monetary policy coordination in India, where it is crucial to analyse the efficacy of high interest rate regime on public debt management. Our results also refute the popular belief that deficits determine interest rates in the context of emerging economies. |
| Date: | 2024–10 |
| URL: | https://d.repec.org/n?u=RePEc:npf:wpaper:24/419 |
| By: | Rapetti, Martin; Libman, Emiliano; Carrera, Gonzalo |
| Abstract: | By the mid-2000s, Latin American countries had achieved macroeconomic stability: inflation was low, fiscal results were balanced, and external accounts were on a sustainable path, far from the frequent threat of currency crises. Although the trajectories that had brought them there had broadly been similar, from that point onwards they began to diverge. Brazil, Chile, Colombia, Mexico, Paraguay, Peru, and Uruguay managed to maintain macroeconomic stability by gradually adopting macroeconomic schemes of “good practices” based on four pillars: 1) monetary policy frameworks based on inflation targeting, managed by independent and largely technocratic Central Banks; 2) exchange rate policies of managed floating and foreign exchange reserves accumulation; 3) institutional fiscal policies that seek to maintain a countercyclical bias and the sustainability of public debt; and 4) full integration with the international capital markets. On the other hand, Argentina, Bolivia, Ecuador, and Venezuela followed a different path, with more erratic macroeconomic policy strategies that favored short-term goals and relegated macroeconomic stability to the background. The evidence presented in this article suggests that countries that did not adopt the “good practices” framework experienced higher macroeconomic instability, lower growth, and less poverty reduction. |
| Keywords: | Latin America, Inflation Targets, Fiscal Rules, Central Bank Independence |
| JEL: | F40 N16 O54 |
| Date: | 2024–10–04 |
| URL: | https://d.repec.org/n?u=RePEc:pra:mprapa:122289 |
| By: | Boran Plong; Neil Maru |
| Abstract: | The Canadian Overnight Repo Rate (CORRA) measures the cost of overnight general collateral Canadian-dollar repurchase agreements (repos). Since late May 2024, the volume of trades that make up CORRA has increased and remained elevated. At the same time, CORRA started being consistently above the Bank of Canada’s policy interest rate. This upward pressure results entirely from industry-wide changes to the settlement period for cash bond trades on the secondary market, from two days to one. The change in the settlement period prompted a rise in volumes in the overnight repo market (which is CORRA-eligible) from the tomorrow-next repo market (which is not CORRA-eligible). In addition, this move has overwhelmingly been one way: demand from hedge funds to fund their long bond positions. This demand existed before but was always traded in the tomorrow-next market, and thus activity in the tomorrow-next repo market has been decreasing by an amount comparable to the increase in the overnight market. We find this mechanical effect has accounted for up to 3 basis points of upward pressure on CORRA. We find no indications that any other factors are contributing to this pressure. Given the new dynamics since May, the Bank has amended the terms of its overnight repo operations. It has also subsequently conducted a series of operations to help reinforce the target for the overnight rate, which had deviated away from the Bank’s policy rate due to this mechanical adjustment. Overnight repos are routine operations that are part of the Bank’s operational framework for implementing monetary policy and reinforcing the policy interest rate. |
| Keywords: | Financial markets; Interest rates; Monetary policy implementation |
| JEL: | D4 D5 D53 E4 E43 E44 E5 E52 G1 G12 |
| Date: | 2024–08 |
| URL: | https://d.repec.org/n?u=RePEc:bca:bocsan:24-21 |
| By: | Alan S. Blinder (Princeton University) |
| Abstract: | There is little doubt that the Federal Reserve was late to start raising interest rates as inflation rose in 2021-22. The Federal Open Market Committee (FOMC) made a substantial, though perhaps understandable, error in failing to raise interest rates until March 2022. Much of that policy error can be attributed to faulty forecasts of inflation, which the Federal Reserve shared with many other forecasters. It was not an outlier. But the error was not quite as consequential as the Fed's sharpest critics allege. Even if the FOMC had started to hike rates earlier, the econometric evidence suggests that the effects on peak inflation would likely have been small. Supply constraints, not excess demand, ruled the roost. They came, driving inflation higher; and then they went, pulling inflation down. Blinder says that the FOMC's August 2020 framework shoulders more of the blame for the inflationary surge than it should--probably because the new wording revised both of the Fed's goals, low inflation and high employment, in dovish directions. For that reason alone, the framework will almost certainly be changed in 2025, given the high inflation since. But how? Blinder suggests that the August 2020 change in the employment goal, from symmetry to "shortfalls, " is sensible and probably not too important anyway. But the change in the inflation goal, from a 2 percent point target to flexible average inflation targeting (FAIT), was probably consequential. It may have made the FOMC slow on the draw as inflation gathered steam, and it may have kept monetary policy too tight for too long in 2024. In both directions, Blinder argues, a 1.5 to 2.5 percent target range would be a better choice. To answer the question in the title of this Policy Brief, that may be the structural flaw the Fed should fix. |
| Date: | 2024–10 |
| URL: | https://d.repec.org/n?u=RePEc:iie:pbrief:pb24-11 |
| By: | Anthony Brassil (Reserve Bank of Australia); Yahdullah Haidari (Reserve Bank of Australia); Jonathan Hambur (Reserve Bank of Australia); Gulnara Nolan (Reserve Bank of Australia); Callum Ryan (Reserve Bank of Australia) |
| Abstract: | This paper explores the formation of households' wage and inflation expectations using a common dataset and framework, documenting a number of stylised facts. We find that households tend to form wage and inflation expectations somewhat differently. Households associate higher wages growth with good economic outcomes, but higher inflation with worse economic outcomes. Wages expectations also tend to be somewhat more forward looking, while inflation expectations are more backward looking, especially for lower income households, and place a disproportionate weight on past fuel prices. These findings paint a picture of households having a somewhat 'supply-side' view of inflation, where shocks that push up inflation also weaken the economy, but a more 'demand-side' view of wages, where shocks that push up wages also strengthen the economy, which may make communication of monetary policy and the outlook more challenging. |
| Keywords: | inflation expectations; wage growth |
| JEL: | D84 E31 J31 |
| Date: | 2024–10 |
| URL: | https://d.repec.org/n?u=RePEc:rba:rbardp:rdp2024-07 |
| By: | Antonio Diez de los Rios |
| Abstract: | The Bank of Canada’s Government of Canada Bond Purchase Program, launched in response to the COVID-19 pandemic, lowered the weighted average maturity of the Government of Canada’s debt by approximately 1.4 years. This in turn reduced Canadian 10-year and 5-year zero-coupon yields by 84 and 52 basis points, respectively. |
| Keywords: | Asset pricing; Central bank research; Coronavirus disease (COVID-19); Interest rates; Monetary policy |
| JEL: | E4 E43 E5 E52 G1 G12 H6 H63 |
| Date: | 2024–10 |
| URL: | https://d.repec.org/n?u=RePEc:bca:bocsan:24-22 |
| By: | Ferreira, Alex (University of São Paulo); Mullen, Rory (Warwick Business School); Ricco, Giovanni (École Polytechnique, University of Warwick, OFCE & CEPR); Viswanath-Natraj, Ganesh (Warwick Business School); Wang, Zijie (Warwick Business School) |
| Abstract: | We study the impact of foreign exchange interventions during periods of tight credit constraints. Expanding on the Gabaix and Maggiori (2015) model, we predict that long-lived spot interventions have larger effects on exchange rates than shortlived swaps, unanticipated interventions are more impactful, and tighter credit constraints amplify effects. Using high-frequency data on Brazilian Central Bank interventions from 1999 to 2023, we find that unanticipated spot sales of USD reserves lead to significant domestic currency appreciation and reduced covered interest parity deviations. Spot interventions outperform swaps, especially when global intermediaries are constrained, and enhance market efficiency by lowering USD borrowing costs. |
| Keywords: | Exchange Rate ; Central Bank ; Interventions ; Yield Curve ; Asset Pricing JEL Codes: E44 ; E58 ; F31 ; G14 |
| Date: | 2024 |
| URL: | https://d.repec.org/n?u=RePEc:wrk:warwec:1522 |
| By: | Vicente da Gama Machado |
| Abstract: | Since the adoption of inflation targeting in Brazil, the literature on core inflation has significantly expanded; however, a comprehensive survey has been lacking. This paper aims at filling this gap by providing a thorough overview of the academic developments and a historical guide to the core inflation measures employed by the Central Bank of Brazil (BCB). Additionally, the paper introduces a unified approach to evaluate the performance of core measures, which is then used to assess the set of official measures currently monitored by the BCB. This approach emphasizes the complementary nature of individual measures and demonstrates the overall favorable relative performance of the core average. |
| Date: | 2024–10 |
| URL: | https://d.repec.org/n?u=RePEc:bcb:wpaper:602 |
| By: | Tess C. Scharlemann; Eileen van Straelen |
| Abstract: | We study how the mortgage interest deduction (MID) constrains mortgage refinancing. Households who deduct mortgage interest from their taxes face a lower post-tax interest rate, reducing the interest savings from refinancing net of taxes. We estimate the effect of the MID on refinancing using the Tax Cuts and Jobs Act (TCJA) of 2017 as a natural experiment. The TCJA doubled the standard deduction, dramatically reducing MID uptake and value. This policy affected borrowers differently based on their pre-existing mortgage interest, federal and state tax rates, and property taxes. We use heterogeneity in borrowers' pre-TCJA exposure to the policy to show that, following the TCJA, the refinancing rate amongst households who lose the MID increased by 25%. In response to a 19 basis point increase in the after-tax mortgage rate, we estimate that refinancing increases 25%. These results suggest that reductions in the MID may improve the pass-through of monetary policy. |
| Keywords: | Consumption; Household Finance; Monetary policy; Mortgages |
| JEL: | E52 G21 E21 D14 |
| Date: | 2024–09–24 |
| URL: | https://d.repec.org/n?u=RePEc:fip:fedgfe:2024-82 |
| By: | Klodiana Istrefi (BANQUE DE FRANCE); Florens Odendahl (BANCO DE ESPAÑA); Giulia Sestieri (BANQUE DE FRANCE) |
| Abstract: | This paper presents the Euro Area Communication Event-Study Database (EA-CED), a new dataset that tracks financial market movements around ECB Governing Council meetings (GC) and inter-meeting communication (IMC). Covering the period from 1999 to 2024, the EA-CED contains intraday changes in euro area financial variables around the time of 304 ECB GC policy announcements and 4, 400 IMC events, consisting mainly of speeches and interviews. We document several new empirical findings on the impact of IMC on financial markets. First, we show that many IMC events are associated with significant market movements, often of similar or larger magnitude than those associated with ECB policy announcements, particularly for yields at longer maturities. Significant effects are not limited to communication from the ECB’s President but extend to other members of the Governing Council. Second, the importance of IMC varies over time, peaking around tightening cycles, particularly in 2022-2023. Third, like ECB GC announcements, IMC events convey multi-dimensional information and lead to surprises regarding the path of monetary policy and the state of the economy. |
| Keywords: | monetary policy, ECB, communication, financial markets, euro area |
| JEL: | E03 E50 E61 |
| Date: | 2024–10 |
| URL: | https://d.repec.org/n?u=RePEc:bde:wpaper:2431 |
| By: | Carolina Celis (Inter-American Development Bank); Arturo Galindo (Inter-American Development Bank); Liliana Rojas-Suarez (Center for Global Development) |
| Abstract: | This paper presents findings from a comprehensive survey of 18 central banks and banking supervisor authorities in Latin America and the Caribbean, including major economies like Argentina, Brazil, Chile, Colombia, and Mexico. The survey aimed to assess the adoption of the Basel III standards across the region and revealed significant diversity in regulatory capital frameworks. Notably, while 75 percent of respondent countries have adopted Basel III for some financial intermediaries, 44 percent still maintain hybrid systems allowing for Basel I or II standards. These results highlight the region's varied approach to financial regulation, pointing to both progress in adopting international standards and the persistence of legacy regulatory regimes. The detailed findings and constructed indexes provide valuable insights into the state of financial regulation in the region, reflecting a landscape of both convergence and divergence in banking supervision practices. |
| Keywords: | Financial Regulation, Banking Supervision, Basel III Adoption |
| JEL: | E58 G21 G28 |
| Date: | 2024–10–10 |
| URL: | https://d.repec.org/n?u=RePEc:cgd:wpaper:705 |
| By: | Boge, Kevin Patrick; Rieth, Malte; Kholodilin, Konstantin |
| JEL: | E52 R12 R31 |
| Date: | 2024 |
| URL: | https://d.repec.org/n?u=RePEc:zbw:vfsc24:302370 |
| By: | Alberto Botta; Eugenio Caverzasi; Alberto Russo |
| Abstract: | With central banks and national governments returning to more conservative monetary and fiscal policies after Covid, the debate about the macroeconomic effects of fiscal rules has revamped. We address this topic via an extended version of the hybrid ABM-SFC model in Botta et al. (2024) that includes a Taylor-type monetary policy rule and a variety of fiscal rules aimed at reducing the public debt-to-GDP ratio. We compare spending-based fiscal rules vastly advocated by international economic institutions with wealth tax-based fiscal policies. We do this in the context of a modern financialized economy where securitization and complex financial products like Asset-Backed Securities (ABS) alter economic dynamics and the effectiveness of monetary policy in controlling inflation. We assume heterogeneous households to track how alternative fiscal strategies affect income and wealth inequality. Our findings are threefold. First, spending-based fiscal rules can reduce the debt-to-GDP ratio in the long term but at the cost of significantly higher unemployment and permanently lower real GDP. Second, wealth tax-based fiscal policies reduce public debt without harming economic performance. Third, perhaps unexpectedly, in a financialized economy, spending-based fiscal austerity may hurt the relative position of rich households in wealth distribution as much as a wealth tax does; this is due to capital losses that spending cuts may eventually induce in households’ financial wealth. In the end, wealth taxes are preferable to spending cuts, and the usual political opposition against them by the rich appears largely unfounded given their potential economic benefits compared to spending-based fiscal austerity. |
| Keywords: | Spending-based fiscal rule, Wealth tax, Securitization |
| JEL: | E44 E63 H63 |
| Date: | 2024–10 |
| URL: | https://d.repec.org/n?u=RePEc:pke:wpaper:pkwp2412 |
| By: | Luis Fernando Colunga Ramos |
| Abstract: | In some advanced and emerging economies, contrary to expectations, it has been observed that increases in short-term interest rates are accompanied by increases in bank credit; a phenomenon referred to as "the loan puzzle." This study investigates, through the estimation of a structural vector autoregressive model using national and sectoral-level data, whether this phenomenon occurred in the Mexican economy between 2001 and 2019. The results suggest that, in response to a positive shock to short-term interest rates, the volume of bank credit to firms exhibits a positive and short-lived response but subsequently decreases. This response is primarily observed in sectors that had the lowest average delinquency rates during the analysis period. This suggests that banks would grant more loans to relatively safer companies, while, in response to such monetary tightening, they would reduce their investments in riskier and longer-term assets, such as consumer loans and loans to the real estate sector. |
| Keywords: | Monetary Policy;Bank Credit;Vector Autoregressive Model |
| JEL: | E51 E52 E58 |
| Date: | 2024–10 |
| URL: | https://d.repec.org/n?u=RePEc:bdm:wpaper:2024-15 |
| By: | Andrej Cupak (National Bank of Slovakia); Pavel Gertler (National Bank of Slovakia); Daniel Hajdiak (National Bank of Slovakia); Jan Klacso (National Bank of Slovakia); Stefan Rychtarik (National Bank of Slovakia) |
| Abstract: | This paper presents the findings from a novel survey examining awareness and interest in the future usage of the digital euro in Slovakia. Approximately 34% of the respondents have already heard or read about the digital euro. Around 26% express an intention to use this new digital currency. The likelihood of its usage depends on political preferences, trust in institutions such as the central bank, and preferences for cash payments, in addition to standard socio-economic factors. The survey also reveals that privacy and transaction security are among the top concerns for potential users. The majority of respondents plan to allocate nearly 20% of their net monthly income to digital euro holdings. These insights may provide valuable guidance for shaping the operational framework of the digital euro and informing future communication strategy. |
| JEL: | D14 E42 E51 E52 |
| Date: | 2024–10 |
| URL: | https://d.repec.org/n?u=RePEc:svk:wpaper:1111 |
| By: | Bora Durdu; Sergio Villalvazo |
| Abstract: | This paper investigates the impact of loan-to-value (LtV) borrowing constraints in models with occasionally binding credit constraints. These constraints give rise to a Fisherian debt-deflation mechanism, where exogenous shocks can trigger cascading effects resulting in significant declines in consumption, asset prices, and borrowing reversals—characteristic of financial crises. However, recent literature challenges traditional view by suggesting that collateral constraints may not always exacerbate financial disturbances but could instead foster dynamics leading to multiple equilibria. Building on this discussion, the paper explores equilibrium asset pricing models with LtV collateral constraints, identifying critical thresholds that govern asset price dynamics, consumption patterns, and current account behaviors. Our analysis uncovers that when the LtV limit is close to zero, tighter constraints induce smaller drops in consumption during crises. Conversely, when the LtV limit is close to one, we observe that tighter constraints induce larger drops in consumption during crises. The nonlinear relationship between the LtV ratio and adverse effects on macroeconomic outcomes aligns with cross-country evidence regarding the relationship between the level of financial development and the severity of consumption declines during crises. |
| Keywords: | Financial crises; Loan-to-value constraints; Debt-deflation |
| JEL: | E31 E37 E52 F41 G01 |
| Date: | 2024–09–20 |
| URL: | https://d.repec.org/n?u=RePEc:fip:fedgfe:2024-81 |