State-Dependent Effects of Loan-to-Value Shocks

This paper presents a Two-Agent New Keynesian (TANK) model with collateral- constrained borrowers
and a time-varying shock to loan-to-value (LTV) ratios. A temporary tightening in lending standards in this
model leads to a sizable drop in macroeconomic aggregates and significant macroeconomic fluctuations.
The analysis shows that effects of shocks to LTV ratios are highly non-linear and state-dependent in the
sense that amplification of shocks depends crucially on steady-state LTV ratios. Shocks when LTV ratios
are already high lead to effects which are substantially stronger than when the steady-state LTV ratios
are comparatively lower. The results in this paper also show that permanent LTV shocks lead to
permanent decline in housing prices – a 10 percentage point decline in steady-state LTV ratio from 0.95
results in more than 0.3% decline in housing prices. A novel finding in this paper is that a permanent
tightening in lending standards leads to a permanent decline in wages. Additionally, other shocks such
as TFP shocks, housing demand shocks and labor supply shocks also show clear state dependence and
have highly persistent effects.