Excess Liquidity, Housing Price Booms and Policy Challenges in China

Abstract:     
Incorporating asymmetric cost and benefit of supplying excess liquidity into an otherwise standard time inconsistency model, this paper offers an explanation of the excess liquidity and housing price booms recently experienced in China. We find that the central bank's incentive to stimulate economic growth with excess liquidity fuels real estate prices and accelerates inflation bias. Therefore, the central bank should free itself from the pressure to achieve an economic growth rate higher than the potential level, and assign an appropriate weight to the real estate price fluctuations in the central bank's objective function, so that the central bank's policy of stimulating economic growth with excess liquidity can be constrained.

Number of Pages in PDF File: 16

Keywords: discretionary monetary policy, excess liquidity, housing price boom, time inconsistency

JEL Classification: E44, E52, E58, E61

Accepted Paper Series