The Effect of Monetary Policy on Housing Tenure Choice as an Explanation for the Price Puzzle

Daniel Dias and Joao Duarte

No 1171, International Finance Discussion Papers from Board of Governors of the Federal Reserve System (U.S.)

Abstract: In this paper we provide an alternative explanation for the price puzzle (Sims 1992) based on the effect of monetary policy on housing tenure choice and the weight of the shelter component in overall CPI. In the presence of nominal or financial frictions, when interest rates increase, the real cost of owning a house increases, and this increase may make some people prefer to rent instead of buying. This change in consumption behavior increases the price of rents relative to other goods. Starting in 1983, homeownership costs are based on a measure of implied owner equivalent rent, which is calculated using observed house rents. This change implies that, directly and indirectly, prices in the rental market almost entirely command the shelter component of CPI, which weighs around 30% in the overall index. When we take these two pieces into account and use CPI net of shelter services as a measure of inflation, we obtain impulse responses of prices to a monetary contraction shock more in line with what is predicted by theory. In addition, our results also suggest that inflation is much less persistent than what is implied by analyses using a measure of inflation that includes shelter services. Our results pass a long list of robustness check exercises and compare well against other explanations of the price puzzle.

Keywords: Price puzzle; Housing tenure choice; Monetary policy; SVAR (search for similar items in EconPapers)
JEL-codes: E31 E43 R21 (search for similar items in EconPapers)
Pages: 27 pages
Date: 2016-06
New Economics Papers: this item is included in nep-mac, nep-mon, nep-opm and nep-ure
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedgif:1171

DOI: 10.17016/IFDP.2016.1171

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