Did Monetary Policy Fuel the Housing Bubble in Ireland?
KU Leuven Discussion Paper Series DPS15.01
40 Pages Posted: 30 Jan 2015
Date Written: January 2015
This paper provides empirical evidence of the role of the euro in the genesis of the recent Irish financial-economic crisis caused by a regional housing boom and its inevitable bust. By using a Taylor-rule, estimated by Generalized Method of Moments, we measure the appropriateness of the ECB’s one-size-fits-all policy rate for the Irish economy. A counterfactual analysis suggests that the Irish interest rate should have been on average 6.5% higher. In addition, using a multivariate housing model, we provide econometric evidence for the causal relationship between the low interest rate and the Irish housing boom. Under an alternative sovereign monetary policy, the average house price would have been 25 to 30 percent lower just before the housing bust in the second quarter of 2007. In addition, it shows that a monetary policy tailored to the needs of the member state is enough to prevent housing prices from dramatically increasing and suggests that it is not necessary to include a lean against house price fluctuations in monetary policy strategies.
Keywords: EMU, Monetary policy, Taylor-rule, Housing bubble
JEL Classification: E5, F6
Suggested Citation: Suggested Citation