Failure to Launch: Housing, Debt Overhang, and the Inflation Option
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Abstract
Can inflating away nominal mortgage liabilities effectively combat recessions? I address this question using a model of illiquid housing, endogenous credit supply, and equilibrium default. I show that, in an ordinary recession, temporarily raising the inflation target has only modest or even counterproductive effects. However, during episodes like the Great Recession, inflation effectively boosts house prices, consumption, and dramatically cuts foreclosures, but only when fixed-rate mortgages are the dominant instrument. The quantitative implications of inflation also vary if other nominal rigidities or demand externalities are present. In the cross section, inflation delivers especially large gains to highly leveraged homeowners.Citation
Hedlund, Aaron. 2019. "Failure to Launch: Housing, Debt Overhang, and the Inflation Option." American Economic Journal: Macroeconomics, 11 (2): 228-74. DOI: 10.1257/mac.20160371Additional Materials
JEL Classification
- D14 Household Saving; Personal Finance
- E31 Price Level; Inflation; Deflation
- E32 Business Fluctuations; Cycles
- E52 Monetary Policy
- G21 Banks; Depository Institutions; Micro Finance Institutions; Mortgages
- R31 Housing Supply and Markets
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