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

Can inflation cure mortgage debt overhang and mitigate the severity of housing busts? Focusing on the Great Recession, I address this question through the lens of a quantitative macroeconomic model of illiquid housing, endogenous mortgage pricing, and equilibrium default. First, I show that an increase in financial frictions accounts for half of the drop in real house prices, household net worth, and consumption during the Great Recession. However, a shock to housing liquidity is key to explaining the drop in housing sales, the increase in average time on the market, and the persistence of high foreclosure sales. A temporary surge of inflation leads to a moderate improvement in real house prices and inflation, though the endogenous contraction of mortgage credit partially offsets the direct debt erosion. However, a policy of nominal price level targeting that institutes high initial inflation followed by an extended disinflation leads to more promising results