Monetary Policy and Regional House-Price Appreciation
This paper examines the link between monetary policy and house-price appreciation by exploiting the fact that monetary policy is set at the national level, but has different effects on state-level activity in the United States. As with any other asset price, house prices can be interpreted as the sum of a fundamental component and a bubble component. In principle, monetary policy can have a different impact on these two components. As a result, the role of monetary policy in house-price appreciation can vary over time with changes in the relative size of the bubble component. This paper addresses the still-debated issue of the role played by monetary policy in the recent housing bubble. More generally, the paper contributes to the ongoing debate about the role of monetary policy in maintaining financial stability.
Key Findings
- Policy accommodation equivalent to 100 basis points on an equilibrium real federal funds rate basis raises housing prices by about 2.5 percent over the next two years. However, the estimated effect increases to 6.6 percent during the early 2000s housing boom.
Implications
The authors' findings confirm other results in the literature that argue for a non-negligible role for monetary policy in affecting housing prices. The authors also find a larger impact of monetary policy on housing prices during the housing boom. Whether the cause behind the emergence of financial imbalances is holding interest rates "too low for too long," however, is far from obvious. It is a regular feature of all business cycles that the unemployment rate eventually falls below its long-run natural level. Thus, from the IS-curve standpoint that the authors are using, there is always a stage in the business cycle when the real rate of interest is not high enough to prevent the unemployment rate from falling below its natural level. This does not mean that monetary policy purposely tries to overheat the economy, but rather that unexpected developments and/or a misjudgment of the underlying strength in activity eventually materialize that push the economy beyond full employment. Typically, overshooting full employment leads to a recession. However, not all recessions have been associated with financial crises.
The authors' novel identification strategy relies on monetary policy having a differential impact across different states. This identification strategy has advantages relative to the more standard practice of isolating a monetary policy "shock," for example, as the residual from an estimated policy reaction function. The reason is that the approach allows them to estimate the effect of monetary policy on housing prices in a panel of U.S. states in the context of a framework with a rich set of controls, which stacks the odds against finding a role for their measure of monetary policy, thus underscoring the importance of their finding that monetary policy does play a role in affecting the price of housing.
Abstract
This paper examines the link between monetary policy and house-price appreciation by exploiting the fact that monetary policy is set at the national level, but has different effects on state-level activity in the United States. This differential impact of monetary policy provides an exogenous source of variation that can be used to assess the effect of monetary policy on state-level housing prices. Policy accommodation equivalent to 100 basis points on an equilibrium real federal funds rate basis raises housing prices by about 2.5 percent over the next two years. However, the estimated effect increases to 6.6 percent during the early 2000s housing boom.