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.
"Failure to Launch: Housing, Debt Overhang, and the Inflation Option."
American Economic Journal: Macroeconomics,
Household Saving; Personal Finance
Price Level; Inflation; Deflation
Business Fluctuations; Cycles
Banks; Depository Institutions; Micro Finance Institutions; Mortgages
Housing Supply and Markets