The Housing Supply Channel of Monetary Policy

Abstract

We study the role of regional housing markets in the transmission of US monetary policy. Using a FAVAR model over 1999q1–2019q4, we find sizeable heterogeneity in the responses of US states to a contractionary monetary policy shock. Part of this regional variation is due to differences in housing supply elasticities, household borrowing constraints, and housing wealth (volatility). House prices and consumption respond more in supply-inelastic states and in states with high household debt, where negative housing wealth effects bite more strongly. Moreover, financial stability risks increase sharply in these areas as mortgage delinquencies and foreclosures surge, worsening banks’ balance sheets. Finally, monetary policy may have a stronger effect on housing tenure decisions in supply-inelastic states, where price-to-rent ratios decline by more, and housing markets appear to be less segmented. Our findings stress the importance of regional housing supply conditions in assessing the macrofinancial effects of rising interest rates.

Keywords: Credit conditions, FAVAR, house prices, monetary policy, regional data, supply elasticities

JEL Classification: C23, E32, E52, R31