Subjective housing price expectations, falling natural rates, and the optimal inflation target

Klaus Adam, Oliver Pfäuti and Timo Reinelt

Journal of Monetary Economics, 2025, vol. 149, issue C

Abstract: U.S. households’ housing price expectations deviate systematically from full-information rational expectations: (i) expectations are updated on average too sluggishly, (ii) expectations initially underreact but subsequently overreact to housing price changes, and (iii) households are overly optimistic (pessimistic) about housing price growth when the price-to-rent ratio is high (low). We show that weak forms of housing price growth extrapolation allow to simultaneously replicate the behavior of housing prices and these deviations from rational expectations as an equilibrium outcome. Embedding housing price growth extrapolation into a sticky price model with a lower-bound constraint on nominal interest rates, we show that lower natural rates of interest increase the volatility of housing prices and thereby the volatility of the natural rate of interest. This exacerbates the relevance of the lower bound constraint and causes Ramsey optimal inflation to increase strongly with a decline in the natural rate of interest.

Keywords: Monetary policy; Subjective housing price expectations; Natural rate of interest; Housing booms; Optimal inflation target; Effective lower bound (search for similar items in EconPapers)
JEL-codes: E31 E44 E52 E58 (search for similar items in EconPapers)
Date: 2025
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Working Paper: Subjective Housing Price Expectations, Falling Natural Rates and the Optimal Inflation Target (2022)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:moneco:v:149:y:2025:i:c:s0304393224001004

DOI: 10.1016/j.jmoneco.2024.103647

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