Mortgage Credit, Aggregate Demand, and Unconventional Monetary Policy

Abstract

I develop a quantitative model of the mortgage market operating in an economy with financial frictions and nominal rigidities. I use this model to study the effectiveness of large-scale asset purchases (LSAPs) by a central bank as a tool of monetary policy. When negative shocks hit, homeowner and financial sector balance sheets are impaired, borrowing constraints bind, asset prices and aggregate demand drop, hampering the transmission of conventional monetary policy. LSAPs boost aggregate demand in a crisis by directing additional lending to homeowners, raising house prices, and establishing expectations of future financial stability. However, legacy household debt depresses output and consumption in recovery. In the long run, a commitment to ongoing use of LSAPs in crises reduces credit and business cycle volatility and redistributes resources from borrowers and intermediaries to savers.

Keywords: Financial Intermediation, Unconventional Monetary Policy, Large-Scale Asset Purchases, Housing Policy, Credit Spread, Intermediary-Based Asset Pricing

JEL Classification: G12, E44, E52, H81, R30