Real Estate, Economic Stability and the New Macro-Financial Policies

Abstract

The influence of real estate on finance and the whole economy has captured significant attention, especially since the aftermath of the Great Recession, because of the potential of this sector to destabilize markets. This paper explores the other way around: housing markets’ capacity to stabilize the economy through different macroprudential policies facing several types of shocks to achieve financial stability as a driver of sustainability. Specifically, a dynamic stochastic general equilibrium model is used to evaluate the effectiveness to stabilize the economy of different macroprudential tools based on the loan-to-value ratio for real estate, on the countercyclical capital buffer for the financial sector and a combination of both tools, facing a housing price shock, a technology shock and a financial shock. The model presents three types of agents (borrowers, entrepreneurs and banks) in an economy with a real estate market, a financial sector, a labor market and a production sector. The government can use different macroprudential policies to stabilize the economy, leaning against the wind of several shocks to achieve economic and financial sustainability. The assessment of the effectiveness of each policy shows that, in the case of a housing sector shock and a technology shock, the more effective policy is the one based on a countercyclical rule on the loan-to-value ratio for the real estate sector as a macroprudential tool. Furthermore, with a house price shock, if the macroprudential authority applies a macroprudential policy based on the countercyclical capital buffer, the shock may be exacerbated. Additionally, when there is a financial shock, the macroprudential authority may face a trade-off between several macro-financial policies depending on its objective. Therefore, it is not recommendable to automatically apply a macroprudential policy without a meticulous analysis of the nature of the shock that the economy is experimenting with and how different policies can stabilize or destabilize the different markets and, therefore, reach higher or lower sustainability.