The Costs of Macroprudential Deleveraging in a Liquidity Trap

IMF Working Papers, June 12, 2020

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We examine the effects of various borrower-based macroprudential tools in a New Keynesian environment where both real and nominal interest rates are low.
Our model features long-term debt, housing transaction costs and a zero-lower bound constraint on policy rates.
We find that the long-term costs, in terms of forgone consumption, of all the macroprudential tools we consider are moderate.
Even so, the short-term costs differ dramatically between alternative tools.
Specifically, a loan-to-value tightening is more than twice as contractionary compared to loan-to-income tightening when debt is high and monetary policy cannot accommodate.

New Keynesian environment with both real and nominal interest rates low.
Long-term debt is explicitly modeled.
Housing transaction costs are included.
Zero-lower bound constraint on policy rates is imposed.
Focus on borrower-based macroprudential tools (examples in keywords: DSTI constraint, LTI economy, LTV constraint, LTV tightening).

Long-term costs (measured as forgone consumption) of the considered macroprudential tools: moderate.
Short-term costs: vary substantially across tools.
Comparative quantitative statement preserved from source: "a loan-to-value tightening is more than twice as contractionary compared to loan-to-income tightening when debt is high and monetary policy cannot accommodate."

Choice of macroprudential instrument matters for short-term macroeconomic outcomes when the policy rate is at the zero lower bound.
Loan-to-value (LTV) tightening has significantly stronger short-run contractionary effects than loan-to-income (LTI) tightening under high-debt, zero-lower-bound conditions.
Consideration of interaction between macroprudential measures and monetary policy space is crucial when designing deleveraging strategies.