Housing Market Dynamics and Macroprudential Policy

We perform an analysis to determine how well the introduction of a countercyclical loanto- value (LTV) ratio can reduce household indebtedness and housing price fluctuations compared with a monetary policy rule augmented with house price inflation. To this end, we construct a New Keynesian model in which a fraction of households borrow against the value of their houses and we introduce news shocks on housing demand. We estimate the model with Canadian data using Bayesian methods. We find that the introduction of news shocks can generate a housing market boom-bust cycle, the bust following unrealized expectations on housing demand. Our study also suggests that a countercyclical LTV ratio is a useful policy to reduce the spillover from the housing market to consumption, and to lean against news-driven boom-bust cycles in housing price and credit generated by expectations of future macroeconomic developments.