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A0293
Title: Financial frictions and housing collateral constraints in a macro model with heuristics Authors:  Corrado Macchiarelli - National Institute of Economic and Social Research (United Kingdom) [presenting]
Paul De Grauwe - London School of Economics (United Kingdom)
Abstract: The role of household debt in the real activity has attracted considerable attention recently mostly in the light of the observed increases in property prices and the increase of household indebtedness prior to the 2008 bust in many countries. The relevant literature on housing points to a number of the mechanism being likely to trigger or amplify real estate cycles, including bubbles. We focus on the interaction between banks and real estate developments, in particular assessing the implications of changing property prices on consumption decisions. We build on a previously described framework to introduce a real estate sector, accounting in itself for an explicit balance sheet dimension for consumers. The model thus results in an economy where - on the demand side - a collateral constraint limits households ability to borrow against the value of the real estate, and - on the supply side - loan supply is constrained by bank capital. This allows studying the interactions of these two limits by drawing a stark distinction between the supply and demand for credit. While lending constraints are not a new feature of this framework, we take a step further and analyse the implications of lending constraints in a bounded rationality framework. Together with considering bounded rationality rules, the model features an endogenous mechanism for describing the probability distribution of housing bubbles.