This paper presents a theory in which expansionary monetary policy causes a rise in leverage. Low mortgage rates encourage buyers to enter the housing market, raising the housing sales rate. Because lenders can resell seized foreclosure inventory at lower cost in such a hot housing market, ex-ante they feel comfortable financing a larger fraction of the house purchase. Consistent with this mechanism, this study documents empirically that the housing sales rate is highly sensitive to monetary policy. Calibrating a New Keynesian macroeconomic model augmented with credit-constrained consumers and with housing market search frictions, this housing liquidity channel of monetary policy contributes substantially to the effect of monetary policy on credit markets and the real economy. More generally, this framework suggests that measures to stimulate housing liquidity, including monetary policy alternatives such as home buyer tax credits, are key to stimulating access to credit.

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This paper presents a theory in which expansionary monetary policy causes a rise in leverage. Low mortgage rates encourage buyers to enter the housing market, raising the housing sales rate. Because lenders can resell seized foreclosure inventory at lower cost in such a hot housing market, ex-ante they feel comfortable financing a larger fraction of the house purchase. Consistent with this mechanism, this study documents empirically that the housing sales rate is highly sensitive to monetary policy. Calibrating a New Keynesian macroeconomic model augmented with credit-constrained consumers and with housing market search frictions, this housing liquidity channel of monetary policy contributes substantially to the effect of monetary policy on credit markets and the real economy. More generally, this framework suggests that measures to stimulate housing liquidity, including monetary policy alternatives such as home buyer tax credits, are key to stimulating access to credit.