Loan-to-Value Shocks and Housing in the Production Function

Author name: 
Sharma V

Using a Two-Agent RBC model with time-varying shock to loan-to-value (LTV) ratios, I show that including housing (real estate or land) in the entrepreneurial production function has profound implications for results. In a model in which housing does not play a role as a production input, an LTV tightening has starkly different effects compared to a model in which it is a factor in the production process. In a setup devoid of a role for housing as a production input, differently from the results in the current literature, an LTV tightening leads to a spike in housing price at impact and a lesser fall afterwards. Other macroeconomic variables such as investment and output fall more at lower initial LTV ratios than at higher steady state LTV ratios. The findings of this paper indicate that housing plays an important role in shaping macroeconomic effects of LTV shocks.

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