Quantitative easing and the loan to collateral value ratio
Journal of Economic Dynamics and Control
We study monetary optimal policy in a New Keynesian model at the zero bound interest rate where households use cash alongside house equity borrowing to conduct transactions. The amount of borrowing is limited by a collateral constraint. When either the loan to value ratio declines or house prices fall, we observe a decrease in the money multiplier. We argue that the central bank should respond to the fall in the money multiplier and therefore to the reduction in house prices or the loan to collateral value ratio. We also find that optimal monetary policy generates a large and persistent fall in the money multiplier in response to the drop in the loan to collateral value ratio.
NOTICE: this is the author’s version of a work that was accepted for publication in Journal of Economic Dynamics and Control. Changes resulting from the publishing process, such as peer review, editing, corrections, structural formatting, and other quality control mechanisms may not be reflected in this document. Changes may have been made to this work since it was submitted for publication. A definitive version was subsequently published in Journal of Economic Dynamics and Control, Volume 45, August 2014, Pages 146–164. doi:10.1016/j.jedc.2014.05.013
Based in part on second author's doctoral dissertation, 2014 http://hdl.handle.net/10871/16503
Vol. 45, pp. 146 - 164