Household leverage, housing markets, and macroeconomic fluctuations

Abstract

This paper examines implications of housing and household leverage on macroeconomic fluctuations under credit shocks in the presence of the zero lower bound (ZLB) on nominal interest rates. To this end, I build a housing model by incorporating houses into a standard deleveraging model and allow debt limits to be endogenous. I find that, under an adverse credit shock, only with high leverage can the housing model generate more macroeconomic fluctuations with the nominal interest rate being more likely to hit the ZLB, compared to the standard deleveraging model without housing. In addition, the relative amplification is more pronounced under a shock that causes the ZLB to bind in both the models. Importantly, the ZLB plays a key role in generating a significant decline in the housing price under a particularly adverse credit shock.