House Prices, Consumption, and Monetary Policy: A Financial Accelerator Approach
Bank of England Working Paper No. 169
38 Pages Posted: 4 Jun 2003
Date Written: December 2002
Abstract
There is a live debate about the role of house prices in the transmission mechanism of monetary policy. Do house prices merely reflect macroeconomic conditions, or are there important feedback effects from house prices to other economic variables? We consider a general equilibrium model where asymmetric information problems create frictions in credit markets used by households. In particular, we apply the financial accelerator mechanism of Bernanke, Gertler and Gilchrist to the household sector. In our economy, houses serve two purposes: they provide a stream of housing services to consumers and they serve as collateral to lower the agency costs related to borrowing. We show that under certain conditions this amplifies and propagates the effect of monetary policy shocks on housing investment, house prices and consumption. We also consider the effect of a structural change in credit markets that lowers the transaction costs of additional borrowing against housing equity. We show that such a change would increase the effect of monetary policy shocks on consumption, but would decrease the effect of monetary policy shocks on house prices and housing investment.
Keywords: House prices, credit frictions, monetary policy, financial accelerator, consumption
JEL Classification: E32, E50, R21
Suggested Citation: Suggested Citation
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