Multi-period fixed-rate loans, housing and monetary policy in small open economies

Release date
01/04/2010
Reference
DP2010/03
Authors
Jaromír Beneš; Kirdan Lees
We investigate the implications of the existence of multi-period fixed-rate loans for the behaviour of a small open economy exposed to finance shocks and housing boom-and-bust cycles. To this end, we propose a simple and analytically tractable method of incorporating multi-period debt into an otherwise standard consumer problem. Our simulations show that multi-period fixed-rate contracts can help insulate the economy from the adverse effects of particular shocks. This insulating mechanism is particularly effective for countries with high debt positions exposed to foreign exchange fluctuations,or countries operating a fixed exchange rate regime.