Monetary Policy and House Price Volatility

Abstract

House prices are of special importance for monetary policy since their sudden
falls are usually associated with credit crunch followed by long-lasting and
painful recessions. Despite several spectacular episodes of such events, each
time house prices exhibit long-lasting growth trend with little volatility around
it, it is argued that this pattern is a “new normal”. This paper shows that a
central bank following this view would increase the volatility of inflation and
output as compared to a policy that assumes high volatility of house prices.
In the former case the monetary authority would conduct too accommodative
monetary policy during abrupt house price expansions significantly increasing
output and inflation fluctuations. In the latter situation, in turn, the policy
would work well irrespective of the realized house price volatility.