Working Paper: NBER ID: w24629
Authors: Klaus Adam; Michael Woodford
Abstract: We analytically characterize optimal monetary policy for a New Keynesian model with a housing sector. If one supposes that the private sector has rational expectations about future housing prices and inflation, optimal monetary policy can be characterized without making reference to housing price developments: commitment to a “target criterion” that refers only to inflation and the output gap is optimal, as in the standard model without a housing sector. But when a policymaker seeks to choose a policy that is robust to potential departures of private sector expectations from model-consistent ones, then the optimal target criterion must also depend on housing prices. In the empirically realistic case where housing is subsidized and where monopoly power causes output to fall short of its optimal level, the robustly optimal target criterion requires the central bank to “lean against” housing prices: following unexpected housing price increases, policy should adopt a stance that is projected to undershoot its normal targets for inflation and the output gap, and similarly aim to overshoot those targets in the case of unexpected declines in housing prices. The robustly optimal target criterion does not require that policy distinguish between “fundamental” and “non-fundamental” movements in housing prices.
Keywords: No keywords provided
JEL Codes: E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Monetary policy decisions (E52) | Housing price movements (R31) |
| Unexpected increases in housing prices (R31) | Tighter monetary policy stance (E52) |
| Unexpected declines in housing prices (R31) | Looser monetary policy stance (E52) |
| Housing prices (R31) | Optimal monetary policy (E63) |
| Distorted expectations (D84) | Policy effectiveness (D78) |