Failure to Launch: Housing, Debt Overhang, and the Inflation Option During the Great Recession

2015 ◽  
Author(s):  
Aaron Hedlund
Keyword(s):  
Great Recession ◽  
Debt Overhang ◽  
The Great Recession

scholarly journals Failure to Launch: Housing, Debt Overhang, and the Inflation Option

2019 ◽  
Vol 11 (2) ◽  
pp. 228-274 ◽  
Author(s):  
Aaron Hedlund
Keyword(s):  
Cross Section ◽  
Great Recession ◽  
House Prices ◽  
Nominal Rigidities ◽  
Fixed Rate ◽  
Inflation Target ◽  
Debt Overhang ◽  
The Great Recession ◽  
Credit Supply ◽  
The Cross

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. (JEL D14, E31, E32, E52, G21, R31)

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