Household Borrowing Constraints and Residential Investment Dynamics

September 14, 2016

By Hashmat Khan and Jean-François Rouillard

Why does residential investment lead output in the US and Canada but it is coincident in eurozone countries? In this paper we explore the role of home-equity loans used to boost consumption as a channel that affects residential investment. We consider a multi-agent model where some home-owning households face borrowing constraints that reflect home-equity loans or refinancing constraints. The main contribution of our paper is to highlight that the severity of the households’ borrowing constraints in an economy can generate both stylized facts of residential investment dynamics. In US and Canada, a greater proportion of households rely on home-equity loans relative to eurozone countries. This difference matters for the distinct residential investment dynamics observed across countries.

This paper puts an additional twist to the long-standing puzzle about residential investment leading the cycle in the US while non-residential investment is lagging in the US. The paper also reinforces that financial institutions do matter.