The Impact of Inflation Shocks on House Prices and Household Debt in the Presence of LTV Ratio Restrictions

Abstract

This study investigates the impact of inflation shocks on house prices and household debt in the presence of loan-to-value(LTV) ratio restrictions, using a two-agent New Keynesian dynamic stochastic general equilibrium model. We find that the crucial mechanism through which inflation shocks and monetary policy responses to these shocks affect house prices and households debt is a decline in the real value of debt. Unexpected inflation reduces the real value of debt, transferring wealth from patient households to impatient households and entrepreneurs. This causes patient households to reduce both consumption and housing stock, while encouraging impatient households to increase housing wealth by borrowing more. If the LTV constraint becomes tighter, however, house prices decline less while household debt shrinks more, in response to inflation shocks. As household debt declines significantly with the tightened lending rule, inflation shocks do not increase impatient households’ real wealth much. © 2022, Korean Econometric Society. All rights reserved.