Loan-to-Value Shocks and Housing in the Production Function

Using a Two-Agent RBC model with time-varying shock to loan-to-value (LTV) ratios, I show that including
housing (real estate or land) in the entrepreneurial production function has profound implications for
results. In a model in which housing does not play a role as a production input, an LTV tightening has
starkly different effects compared to a model in which it is a factor in the production process. In a setup
devoid of a role for housing as a production input, differently from the results in the current literature, an
LTV tightening leads to a spike in housing price at impact and a lesser fall afterwards. Other
macroeconomic variables such as investment and output fall more at lower initial LTV ratios than at higher
steady state LTV ratios. The findings of this paper indicate that housing plays an important role in shaping
macroeconomic effects of LTV shocks.