Working Paper: CEPR ID: DP14445
Authors: Klaus Adam; Michael Woodford
Abstract: We analytically characterize optimal monetary policy for an augmented New Keynesian model with a housing sector. With rational private sector expectations about housing prices and inflation, optimal monetary policy can be characterized by a standard `target criterion' that refers to inflation and the output gap, without making reference to housing prices. When the policymaker is concerned with potential departures of private sector expectations from rational ones and seeks a policy that is robust against such possible departures, then the optimal target criterion must also depend on housing prices. For empirically realistic cases, the central bank should then `lean against' housing prices, i.e., following unexpected housing price increases (decreases), policy should adopt a stance that is projected to undershoot (overshoot) its normal targets for inflation and the output gap. Robustly optimal policy does not require that the central bank distinguishes between `fundamental' and `non-fundamental' movements in housing prices.
Keywords: No keywords provided
JEL Codes: D81; D84; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| optimal monetary policy (E63) | target criterion (C52) |
| rational expectations (D84) | target criterion (C52) |
| deviations from rational expectations (D84) | optimal target criterion (L21) |
| lean against unexpected increases in housing prices (R21) | optimal monetary policy (E63) |
| lean against housing price increases (R21) | mitigate adverse effects of belief distortions on welfare (D91) |
| optimal monetary policy (E63) | welfare outcomes (I38) |
| belief distortions (G41) | equilibrium dynamics (D50) |