Logo
ScienceStack
Table of Contents
Fetching ...
Sign In

A Semi-Structural Model with Household Debt for Israel

Alex Ilek, Nimrod Cohen

Abstract

We propose a semi-structural DSGE model for the Israeli economy, as a small open economy, which contains a financial friction in the household sector credit market. Such a friction is reflected in a positive relationship between households' leverage ratio and their interest rate (credit spread) on debt, as evident in the Israeli data. Our main purpose is to evaluate the implications of such a friction on the implementation of monetary policy and macroprudential policy. Our two main findings are: First, it is important that the monetary policy will react also to developments in the credit market, such as credit spread widening, to increase effectiveness in achieving its main goals of stabilizing inflation and real activity. Second, macroprudential policy may increase the sensitivity of households' credit spread to their leverage. Thus, this policy can mitigate or even prevent over-borrowing and reduce the risk of a debt deleveraging crisis. Moreover, in a case of demand weakness and debt deleveraging, in addition to accommodative monetary policy, the macroprudential policy may contribute to stimulating demand due to a corresponding reduction in credit spread.

A Semi-Structural Model with Household Debt for Israel

Abstract

We propose a semi-structural DSGE model for the Israeli economy, as a small open economy, which contains a financial friction in the household sector credit market. Such a friction is reflected in a positive relationship between households' leverage ratio and their interest rate (credit spread) on debt, as evident in the Israeli data. Our main purpose is to evaluate the implications of such a friction on the implementation of monetary policy and macroprudential policy. Our two main findings are: First, it is important that the monetary policy will react also to developments in the credit market, such as credit spread widening, to increase effectiveness in achieving its main goals of stabilizing inflation and real activity. Second, macroprudential policy may increase the sensitivity of households' credit spread to their leverage. Thus, this policy can mitigate or even prevent over-borrowing and reduce the risk of a debt deleveraging crisis. Moreover, in a case of demand weakness and debt deleveraging, in addition to accommodative monetary policy, the macroprudential policy may contribute to stimulating demand due to a corresponding reduction in credit spread.
Paper Structure (31 sections, 21 equations, 13 figures, 2 tables)

This paper contains 31 sections, 21 equations, 13 figures, 2 tables.

Table of Contents

  1. Introduction
  2. The Model
  3. The SOE model equations
  4. The world economy equations
  5. Calibration
  6. Data
  7. Calibration stages
  8. The elasticity of the spread to Debt-GDP ratio
  9. The elasticity of the NRI to spread
  10. The elasticity of the output gap to NRI
  11. Borrowers' debt aversion
  12. Other parameters
  13. Implications of Financial Friction and Macroprudential Policy
  14. Implication of financial friction and macroprudential policy under monetary policy shock
  15. Financial Accelerator or Financial Decelerator?
  16. ...and 16 more sections

Figures (13)

  • Figure 1: Mortgage leverage vs. spread over time in Israel (2004-2022)
  • Figure 2: Average mortgage nominal fixed interest rate over time in Israel (2011-2022)
  • Figure 3: IRF to positive monetary policy shock
  • Figure 4: IRF to negative credit supply shock
  • Figure 5: IRF of positive credit demand shock (borrowers with low aversion to leverage)
  • ...and 8 more figures