Financial crises may be intensified by the way mortgage lending and housing taxes are currently structured, according to new academic research. The study suggests that existing systems can amplify economic downturns rather than soften them, particularly when falling house prices interact with strict credit conditions. The researchers argue that policymakers should reconsider how housing is taxed across the economic cycle, proposing higher taxes on housing purchases during periods of strong growth alongside temporary subsidies during recessions.

The research, published in a leading economics journal, warns that without carefully designed intervention, downturns can trigger a damaging feedback loop. As house prices fall, highly indebted households are often forced to sell their homes at depressed values. These so-called fire sales then push prices even lower, weakening household balance sheets and tightening borrowing conditions across the economy. This dynamic, the study argues, deepens recessions unnecessarily and spreads financial stress from borrowers to the broader economy.

At the heart of the analysis is the claim that today’s credit and tax arrangements leave the economy overly exposed to sudden shocks. When housing serves as collateral for borrowing, even modest price declines can sharply reduce access to credit. Families facing job losses or income reductions during a downturn are therefore hit twice: first by the shock itself, and then by collapsing house prices that restrict their ability to smooth consumption or refinance debt. The study finds that this vulnerability is not inevitable, but rather the result of policy choices that fail to respond adequately to different phases of the economic cycle.

The authors emphasise that the most effective interventions occur after a downturn has begun, rather than in attempts to curb borrowing in advance. By cushioning falls in house prices during recessions, governments can protect households at their most fragile moment. This protection, in turn, helps stabilise the broader economy by preventing sharp contractions in credit and spending. The research suggests that relatively modest, temporary housing subsidies introduced during downturns can have outsized benefits compared with more restrictive policies applied during boom periods.

To reach these conclusions, the study employed a quantitative economic model designed to replicate key features of real-world housing and credit markets. Thousands of simulated economies were generated in which house prices determined how much households could borrow. The researchers examined how taxing housing purchases during high-productivity periods and subsidising them during low-productivity periods affected prices, credit availability, and consumption. The model distinguished between two types of households — borrowers and savers — and tracked how each group responded to different policy regimes.

The results show that taxing housing in good times does little to restrain excessive borrowing. By contrast, subsidising housing investment during recessions raises house prices precisely when the financial system is most vulnerable. This support helps prevent forced sales and sharp price collapses, easing the collateral constraints that typically choke off credit access during downturns. Importantly, the study finds that both borrowers and savers benefit in the long run. More stable housing markets improve credit conditions, strengthen household balance sheets, and reduce the lasting economic damage caused by crises.

Overall, the research challenges the conventional emphasis on pre-emptive restrictions and instead argues for targeted, state-contingent intervention. By focusing on recovery rather than restraint, policymakers could protect living standards, limit financial instability, and reduce the depth and duration of future recessions.

More information: Matteo Iacoviello et al, Optimal credit market policy, Journal of Economic Dynamics and Control. DOI: 10.1016/j.jedc.2025.105223

Journal information: Journal of Economic Dynamics and Control Provided by University of Surrey