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Banking Competition, Housing Prices and Macroeconomic Stability

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  • Javier Andrés
  • Oscar Arce

Abstract

We develop a dynamic general equilibrium model with an imperfectly competitive bank-loans market and collateral constraints that tie investors credit capacity to the value of their real estate holdings. Banks set optimal lending rates taking into account the effects of their price policies on their market share and on the volume of funds demanded by each customer. Lending margins have a significant effect on aggregate variables. Over the long run, fostering banking competition increases total consumption and output by triggering a reallocation of available collateral towards investors. However, as regards the short-run dynamics, we find that most macroeconomic variables are more responsive to exogenous shocks in an environment of highly competitive banks. Key to this last result is the reaction of housing prices and their effect on borrowers' net worth. The response of housing prices is more pronounced when competition among banks is stronger, thus making borrowers' net worth more vulnerable to adverse shocks and, specially, to monetary contractions. Thus, regarding changes in the degree of banking competition, the model generates a trade-off between the long run level of economic activity and its stability at the business cycle frequency.
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Suggested Citation

  • Javier Andrés & Oscar Arce, 2012. "Banking Competition, Housing Prices and Macroeconomic Stability," Economic Journal, Royal Economic Society, vol. 122(565), pages 1346-1372, December.
    • Handle: RePEc:ecj:econjl:v:122:y:2012:i:565:p:1346-1372
    DOI: j.1468-0297.2012.02531.x
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    More about this item

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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