The macroeconomic effects of macroprudential policy

Summary

Focus

We measure the effects of changes in maximum loan-to-value (LTV) ratios, an important macroprudential policy, on the core objectives of monetary policy to stabilise output and inflation for a panel of 56 economies over more than two decades. We also examine if such changes in maximum LTV ratios help moderate credit and asset price growth.

Contribution

This paper is the first in the literature that uses a narrative approach to identify exogenous changes in macroprudential policy measures based on a detailed reading of policymakers' objectives. We also consider the size and scope of changes in maximum LTV ratios to capture the intensity of policy actions and their causal effects.

Findings

We find that changes in maximum LTV ratios have modest and imprecisely estimated effects on output and inflation. The output effect is more pronounced in emerging market economies than in advanced economies, and mainly driven by tightening LTV limits. We also find that tightening LTV limits reduces housing credit and house prices. Our results indicate that for central banks, macroprudential measures may serve as a complementary policy tool that does not interfere with the core objectives of monetary policy in a major way.

Abstract

Central banks increasingly rely on macroprudential measures to manage the financial cycle, but the effects of such policies on the core objectives of monetary policy to stabilise output and inflation are largely unknown. In this paper, we quantify the effects of changes in maximum loan-to-value (LTV) ratios on output and inflation. We rely on a narrative identification approach based on detailed reading of policymakers' objectives when implementing the measures. We find that over a four-year horizon, a 10 percentage point decrease in the maximum LTV ratio leads to a 1.1% reduction in output. As a rule of thumb, the impact of a 10 percentage point LTV tightening can be viewed as roughly comparable to that of a 25 basis point increase in the policy rate. However, the effects are imprecisely estimated and the effect is only present in emerging market economies. We also find that tightening LTV limits has larger economic effects than loosening them. At the same time, we show that changes in maximum LTV ratios have substantial effects on credit and house price growth. Using inverse propensity weights to re-randomise LTV actions, we show that these effects are likely causal.

JEL classification: E58, G28

Keywords: macroprudential policy, loan-to-value ratios, local projections, narrative approach