This paper quantitatively accounts for the cyclical dynamics of key macroeconomic housing and mortgage market variables using a tractable, search-theoretic model of housing with equilibrium mortgage default. To explain these dynamics, the model highlights the importance of liquidity spirals which arise from the interaction of search frictions and en- dogenous credit constraints. During housing busts, longer selling times spill over into higher foreclosure risk, thereby magnifying the response of credit constraints to the depressed housing market.
This paper investigates the macroeconomic effects of search risk in the housing
market. To do so, I introduce a tractable directed search model of housing with mul-
tidimensional buyer and seller heterogeneity. I incorporate this framework in an in-
complete markets macroeconomic model with long-term mortgages and equilibrium
default. I show that search risk spills over into higher foreclosure risk by creating a
debt overhang problem. Heavily indebted sellers post high selling prices, take a long
Can inﬂating away nominal mortgage liabilities cure debt overhang and combat a severe housing bust? With a focus on the Great Recession, I address this question using a structural macroeconomic model of illiquid housing, endogenous credit supply, and equilibrium default. First, I show that the model successfully replicates and provides insight into the dynamics of the U.S. economy since 2006. Second, I show that temporarily raising the inﬂation target would have cut foreclosures by over 60% and led to a more robust recovery in real economic variables.