Banking Competition, Housing Prices and Macroeconomic Stability

40 Pages Posted: 12 Jan 2009

See all articles by Javier Andrés

Javier Andrés

University of Valencia - Department of Economics

Oscar Arce

Banco de España

Date Written: January 8, 2009

Abstract

We develop a dynamic general equilibrium model with an imperfectly competitive bank-loans market and collateral constraints that tie investors credit capacity to the value of their real estate holdings. Banks set optimal lending rates taking into account the effects of their price policies on their market share and on the volume of funds demanded by each customer. Lending margins have a significant effect on aggregate variables. Over the long run, fostering banking competition increases total consumption and output by triggering a reallocation of available collateral towards investors. However, as regards the short-run dynamics, we find that most macroeconomic variables are more responsive to exogenous shocks in an environment of highly competitive banks. Key to this last result is the reaction of housing prices and their effect on borrowers' net worth. The response of housing prices is more pronounced when competition among banks is stronger, thus making borrowers' net worth more vulnerable to adverse shocks and, specially, to monetary contractions. Thus, regarding changes in the degree of banking competition, the model generates a trade-off between the long run level of economic activity and its stability at the business cycle frequency.

Keywords: banking competition, collateral constraints, housing prices

JEL Classification: E32, E43, E44, G21

Suggested Citation

Andrés, Javier and Arce, Oscar, Banking Competition, Housing Prices and Macroeconomic Stability (January 8, 2009). Banco de Espana Working Paper No. 0830. Available at SSRN: https://ssrn.com/abstract=1325275 or http://dx.doi.org/10.2139/ssrn.1325275

Javier Andrés (Contact Author)

University of Valencia - Department of Economics ( email )

E-46022 Valencia, Valencia E-46022
Spain
(34 96) 382 8260 (Phone)
(34 96) 382 8249 (Fax)

Oscar Arce

Banco de España ( email )

Alcala 50
Madrid 28014
Spain

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