Optimal Monetary Policy Rules and House Prices: The Role of Financial Frictions

Abstract

We probe the scope for reacting to house prices in simple and implementable monetary policy rules, using a New Keynesian model with a housing sector and financial frictions on the household side. We show that the socialwelfare-maximizing monetary policy rule features a reaction to house price variations, when the latter are generated by housing demand or financial shocks. The sign and size of the reaction crucially depend on the degree of financial frictions in the economy. When the share of constrained agents is relatively small, the optimal reaction is negative, implying that the central bank must move the policy rate in the opposite direction with respect to house prices. However, when the economy is characterized by a sufficiently high average loan-to-value ratio, then it becomes optimal to counter house price increases by raising the policy rate.JEL codes: E20, E44, E52

Turkish Housing Market Dynamics: An Estimated DSGE Model

“…In literature, there is no consensus on whether central banks should respond to housing prices or not. However, in recent years, there have been several studies that analyse the extended Taylor rule by incorporating asset and house prices in the central bank’s response function (Aspachs-Bracons & Rabanal, 2011; Finocchiaro & Heideken, 2013; Fuhrer & Tootell, 2008; Gupta & Sun, 2020; Kannan et al, 2012; Notarpietro & Siviero, 2015; Sun & Tsang, 2014). However, so far, there has been no study which takes into account house prices in Turkey.…”

Global banking, financial spillovers and macroprudential policy coordination

“…2009; Christoffel and Schabert 2015). For the housing preference parameter, , we use the same value 0.1 as in Notarpietro and Siviero (2015). The share parameter in the index of money holdings, , which corresponds to the relative share of cash in narrow money, is set at 0.2 to capture the predominant use of deposits in transactions in both regions.…”

“…The parameter for composite monetary assets, 𝜂 x , is set at a low value, 0.01, to capture the common assumption in the literature that the direct utility value of money is fairly small (see, for instance, Coenen et al 2009;Christoffel and Schabert 2015). For the housing preference parameter, 𝜂 H , we use the same value 0.1 as in Notarpietro and Siviero (2015). The share parameter in the index of money holdings, 𝜈, which corresponds to the relative share of cash in narrow money, is set at 0.2 to capture the predominant use of deposits in transactions in both regions.…”

Incorporating asset price stability in the European Central Bank's inflation targeting framework

“…Mishkin (2007) reviews the main housing‐related channels of the monetary transmission mechanism and discusses how the housing sector might be a source of financial instability, and whether such instability could affect the ability of a central bank to stabilize the overall economy. Notarpietro and Siviero (2015) probe the scope for reacting to house prices in implementable and straightforward monetary policy rules, using a New Keynesian model with a housing sector and financial frictions on the household side. Nutahara (2017) finds that if housing prices are a target of a central bank, the monetary policy response to asset prices is helpful for equilibrium determinacy.…”

“…Although housing has a dual role as a store of wealth and as durable consumption good (Case, Quigley, & Shiller, 2005; Corradin, Fillat, & Vergara‐Alert, 2014; Corradin & Fontana, 2013), its market is prone to boom and bust episodes (Beltratti & Morana, 2010; Reinhart & Rogoff, 2009). This variation leads to financial instability and as such the literature has debated whether this is a suitable guide or predictor for central banks' policymakers to achieve better equilibrium (Mishkin, 2007; Notarpietro & Siviero, 2015; Nutahara, 2017).…”