The financial accelerator in the housing market via collateral effects and the role of monetary policy in an estimated New Keynesian DSGE model : A Norwegian case study

This thesis aims to show the financial accelerator mechanism in the housing sector using Norwegian data for the period 1995-2010. Housing is the most important investment decision an agent makes during his/her lifetime. Most Norwegian households own their own home and have during the last 15 years experienced an astonishing 400% nominal rate of return on their investment. Mortgage Equity Withdrawal (MEW) is a relatively new phenomenon that allows households to withdraw money from increasing housing markets to finance increased spending today. Seeing that more than 50% of household assets are tied to housing, adverse changes in the housing market will consequently have severe repercussions for the rest of the economy through the MEW channel. Real and monetary shocks hitting the economy affect the net worth of households and therefore amplify and propagate the initial shock, making it more persistent and longer lasting. This is known as the financial accelerator in the literature. This thesis is divided into two parts. First, I estimate a closed economy New Keynesian Dynamic Stochastic General Equilibrium (DSGE) model for Norwegian data using a Bayesian framework. I then look into the importance of collateral effects in amplifying monetary shocks to the economy and hypothesise what would happen if the wage share of the credit constrained consumers increase. I find that during the last decade, there has been a liberalisation of credit markets and it has become increasingly easier to obtain credit, leading to the consumption boom we are experiencing. Having realised that the sheer size of household debt has grown substantially more than income the last couple of decades, it is a concerning development and one that should not be taken easily. Second, I look into the monetary policy rule and theorise whether central banks should aim to stabilise asset prices as well as keeping inflation and output stable. I find that incorporating asset prices in the policy specification of the central bank leads to a statistically insignificant coefficient. This is not in contrast to the literature on this field of research, although some studies have conversely found that it will be welfare enhancing for the central bank to stabilise asset prices as well