Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/102274
Authors: 
Mendicino, Caterina
Punzi, Maria Teresa
Year of Publication: 
2014
Series/Report no.: 
FinMaP-Working Paper 10
Abstract: 
This paper evaluates the monetary and macroprudential policies that mitigate the procyclicality arising from the interlinkage4s between current account deficits and financial vulnerabilities. We develop a two-country dynamic stochastic general equilibrium (DSGE) model with heterogeneous households and collateralised debt. The model predicts that external shocks are important in driving current account deficits that are coupled with run-ups in house prices and household dept. In this context, optimal policy features an interestrate response to credit and a LTV ration that countercyclically responds to house price dynamics. By allowing an interest-rate response to changes in financial variables, the monetary policy authority improves social welfare, because of the large welfare gains accrued to the savers. The additional use of a countercyclical LTV ratio that responds to house prices, increases the ability of borrowers to smooth consumption over the cycle and is Pareto improving. Domestic and foreign shocks account for a similar fraction of the welfare gains delivered by such a policy.
Subjects: 
house prices
financial frictions
global imbalances
saving glut
dynamic loan-to value ratios
monetary policy
optimized simple rules
JEL: 
C33
E51
F32
G21
Document Type: 
Working Paper
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