Optimal monetary policy rules and house prices: the role of financial frictions

Alessandro Notarpietro and Stefano Siviero

No 993, Temi di discussione (Economic working papers) from Bank of Italy, Economic Research and International Relations Area

Abstract: We probe the scope for reacting to house prices in simple and implementable monetary policy rules, using a New Keynesian model with a housing sector and financial frictions on the household side. We show that the social welfare maximizing monetary policy rule features a reaction to house price variations, when the latter are generated by housing demand or financial shocks. The sign and size of the reaction crucially depend on the degree of financial frictions in the economy. When the share of constrained agents is relatively small, the optimal reaction is negative, implying that the central bank must move the policy rate in the opposite direction with respect to house prices. However, when the economy is characterized by a sufficiently high average loan-to-value ratio, then it becomes optimal to counter house price increases by raising the policy rate.

Keywords: Optimal simple interest rate rules; Housing; Credit frictions. (search for similar items in EconPapers)
JEL-codes: E20 E44 E52 (search for similar items in EconPapers)
Date: 2014-10
New Economics Papers: this item is included in nep-dge, nep-mac, nep-mon and nep-ure
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Journal Article: Optimal Monetary Policy Rules and House Prices: The Role of Financial Frictions (2015)
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Persistent link: https://EconPapers.repec.org/RePEc:bdi:wptemi:td_993_14

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