We use a DSGE model with financial frictions, leverage limits on banks, loan-to-value limits and debt-service ratio (DSR) limits on mortgage borrowing, to examine: i) the effects of different macroprudential policies on key macro aggregates; ii) their interaction with each other and with monetary policy; and iii) their effects on the volatility of key macroeconomic variables and on welfare. We find that capital requirements can nullify the effects of financial frictions and reduce the effects of shocks emanating from the financial sector on the real economy. LTV limits, on their own, are not sufficient to constrain household indebtedness in booms, though can be used with capital requirements to keep debt-service ratios under control. Finally, DSR limits lead to a significant decrease in the volatility of lending, consumption and inflation, since they disconnect the housing market from the real economy. Overall, DSR limits are welfare improving relative to any other macroprudential tool.
Stephen Millard, Margarita Rubio and Alexandra Varadi
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Sir Clive Granger BuildingUniversity of NottinghamUniversity Park Nottingham, NG7 2RD
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