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Monetary Policy, Residential Investment, and Search Frictions: An Empirical and Theoretical Synthesis

Kurt Lunsford

No 1607, Working Papers (Old Series) from Federal Reserve Bank of Cleveland

Abstract: Using a factor-augmented vector autoregression (FAVAR), this paper shows that residential investment contributes substantially to GDP following monetary policy shocks. Further, it shows that the number of new housing units built, not changes in the sizes of existing or new housing units, drives residential investment fluctuations. Motivated by these results, this paper develops a dynamic stochastic general equilibrium (DSGE) model where houses are built in discrete units and traded through searching and matching. The search frictions transmit shocks to housing construction, making them central to producing fluctuations in residential investment. The interest rate spread between mortgages and risk-free bonds also transmits monetary policy to the housing market. Following monetary shocks, the DSGE model matches the FAVAR?s positive co-movement between nondurable consumption and residential construction spending. In addition, the FAVAR shows that the mortgage spread falls following an expansionary monetary shock, providing empirical support for the DSGE model?s monetary transmission mechanism.

Keywords: Factor-augmented vector autoregression; search theory; monetary policy; interest rate spread; residential investment (search for similar items in EconPapers)
JEL-codes: C32 E40 R31 E50 E30 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac, nep-mon and nep-ure
Date: 2016-02-12, Revised 2016-02-12
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