William Gatt

Distributional effects of maximum LTV ratio policy

Abstract: Macroprudential policies, although relatively new, have received a lot of attention over the past years by academics and policymakers in advanced economies, due to the financial crisis of 2008. While the goal of these policies is to foster financial stability in the short to medium term, they may have unintended long run consequences since they constrain households' borrowing capacity. This paper explores whether one such policy tool, the maximum loan-to-value (LTV) ratio, induces redistributive effects by causing low wealth households to buy smaller houses or rent. This could limit the size of any capital gains that accrue from future house price appreciation, effectively increasing wealth inequality. To study this hypothesis, I use an Aiyagari-Bewley-Huggett incomplete markets (heterogeneous agents) model with stochastic income endowments in which households face an endogenous borrowing limit in the form of a collateral constraint. This constraint is initially loose, allowing households to lever up against the collateral value of their housing. The introduction of a macroprudential regime imposes a maximum LTV limit, tightening the borrowing constraint permanently. I show that, for a given initial wealth distribution, the introduction of the regime causes households to save more and accumulate wealth, lowering interest rates and raising house prices. This translates to a rightward shift of the lower part of the wealth distribution, effectively reducing, rather than increasing, wealth inequality.

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