Optimal Monetary Policy during Endogenous Housing-Market Boom-Bust Cycles

Hajime Tomura

Staff Working Papers from Bank of Canada

Abstract: This paper uses a small-open economy model for the Canadian economy to examine the optimal Taylor-type monetary policy rule that stabilizes output and inflation in an environment where endogenous boom-bust cycles in house prices can occur. The model shows that boom-bust cycles in house prices emerge when credit-constrained mortgage borrowers expect that future house prices will rise and this expectation is neither shared by savers nor realized ex-post. These boom-bust cycles replicate the stylized features of housing-market boom-bust cycles in industrialized countries. In an environment where mortgage borrowers are occasionally over-optimistic, the central bank should be less responsive to inflation, more responsive to output, and slower to adjust the nominal policy interest rate. This optimal monetary policy rule dampens endogenous boom-bust cycles in house prices, but prolongs inflation target horizons due to weak policy reactions to inflation fluctuations after fundamental shocks.

Keywords: Credit and credit aggregates; Financial stability; Inflation targets (search for similar items in EconPapers)
JEL-codes: E44 E52 (search for similar items in EconPapers)
Pages: 42 pages
Date: 2009
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac, nep-mon and nep-ure
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:bca:bocawp:09-32

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