Optimal Monetary Policy Rules and House Prices: The Role of Financial Frictions

1 Pages Posted: 28 Feb 2015

Date Written: October 23, 2014

Abstract

We probe the scope for reacting to house prices in simple and implementable monetary policy rules, using a New Keynesian model with a housing sector and financial frictions on the household side. We show that the social welfare maximizing monetary policy rule features a reaction to house price variations, when the latter are generated by housing demand or financial shocks. The sign and size of the reaction crucially depend on the degree of financial frictions in the economy. When the share of constrained agents is relatively small, the optimal reaction is negative, implying that the central bank must move the policy rate in the opposite direction with respect to house prices. However, when the economy is characterized by a sufficiently high average loan-to-value ratio, then it becomes optimal to counter house price increases by raising the policy rate.

Keywords: Optimal simple interest rate rules, Housing, Credit frictions

JEL Classification: E20, E44, E52

Suggested Citation

Notarpietro, Alessandro and Siviero, Stefano, Optimal Monetary Policy Rules and House Prices: The Role of Financial Frictions (October 23, 2014). Bank of Italy Temi di Discussione (Working Paper) No. 993. Available at SSRN: https://ssrn.com/abstract=2571298 or http://dx.doi.org/10.2139/ssrn.2571298

Alessandro Notarpietro

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

Stefano Siviero (Contact Author)

Bank of Italy ( email )

Via Nazionale 91
Studi-Divisione Biblioteca e Pubblicazion
00184 Roma
Italy

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