Wealth inequality and the distributional effects of maximum loan-to-value ratio policy

Abstract

Macroprudential policy improves economic outcomes by reducing the likelihood and severity of financial crises. Yet, are there unintended long run consequences to the introduction of a macroprudential policy regime, and are they conditional on the level of wealth inequality? I answer these questions by looking at the effect of a reduction in the maximum loan-to-value (LTV) ratio on homeownership rates, house prices and housing wealth inequality across two economies with different initial wealth dispersion. I use a heterogeneous agent model in which households face an endogenous borrowing limit in the form of a collateral constraint. A reduction in the LTV limit tightens the borrowing constraint and changes the levels of wealth at which households rent or become constrained or unconstrained owners. The key finding of this paper is that initial conditions matter; a greater share of households is affected when wealth is distributed more equally. This larger impact on aggregate demand leads to a stronger fall in house prices and a larger rise in the share of constrained homeowners and housing wealth inequality. The effects are also non-linear in the LTV ratio, with progressively stronger effects at lower LTV ratios.