Working Paper: NBER ID: w26833
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” in terms of inflation and the output gap, that makes no reference to housing prices. If instead 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 will also depend on housing prices. For empirically realistic cases, robustness requires the central bank to “lean against” housing prices, i.e., to adopt a stance that is projected to undershoot (overshoot) its normal targets for inflation and the output gap following unexpected housing price increases (decreases). Notably, robustly optimal policy does not require that the central bank distinguish between “fundamental” and “non-fundamental” movements in housing prices.
Keywords: Monetary Policy; New Keynesian Model; Housing Prices; Expectations
JEL Codes: C61; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| monetary policy (E52) | housing prices (R31) |
| housing prices (R31) | monetary policy (E52) |
| housing prices (R31) | inflation (E31) |
| housing prices (R31) | output gap targets (E61) |
| private sector expectations (E69) | monetary policy (E52) |
| housing price surprises (R31) | monetary policy decisions (E52) |