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Failure to Launch: Housing, Debt Overhang, and the Inflation Option†

Failure to Launch: Housing, Debt Overhang, and the Inflation Option† AbstractCan inflating away nominal mortgage liabilities effectively combat recessions? I address this question using a model of illiquid housing, endogenous credit supply, and equilibrium default. I show that, in an ordinary recession, temporarily raising the inflation target has only modest or even counterproductive effects. However, during episodes like the Great Recession, inflation effectively boosts house prices, consumption, and dramatically cuts foreclosures, but only when fixed-rate mortgages are the dominant instrument. The quantitative implications of inflation also vary if other nominal rigidities or demand externalities are present. In the cross section, inflation delivers especially large gains to highly leveraged homeowners. (JEL D14, E31, E32, E52, G21, R31) http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png American Economic Journal: Macroeconomics American Economic Association

Failure to Launch: Housing, Debt Overhang, and the Inflation Option†

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Publisher
American Economic Association
Copyright
Copyright © 2019 © American Economic Association
ISSN
1945-7715
DOI
10.1257/mac.20160371
Publisher site
See Article on Publisher Site

Abstract

AbstractCan inflating away nominal mortgage liabilities effectively combat recessions? I address this question using a model of illiquid housing, endogenous credit supply, and equilibrium default. I show that, in an ordinary recession, temporarily raising the inflation target has only modest or even counterproductive effects. However, during episodes like the Great Recession, inflation effectively boosts house prices, consumption, and dramatically cuts foreclosures, but only when fixed-rate mortgages are the dominant instrument. The quantitative implications of inflation also vary if other nominal rigidities or demand externalities are present. In the cross section, inflation delivers especially large gains to highly leveraged homeowners. (JEL D14, E31, E32, E52, G21, R31)

Journal

American Economic Journal: MacroeconomicsAmerican Economic Association

Published: Apr 1, 2019

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