Optimal Monetary Policy during Endogenous Housing-Market Boom-Bust Cycles
AbstractThis paper uses a small-open economy model for the Canadian economy to examine the optimal Taylor-type monetary policy rule that stabilizes output and inflation in an environment where endogenous boom-bust cycles in house prices can occur. The model shows that boom-bust cycles in house prices emerge when credit-constrained mortgage borrowers expect that future house prices will rise and this expectation is neither shared by savers nor realized ex-post. These boom-bust cycles replicate the stylized features of housing-market boom-bust cycles in industrialized countries. In an environment where mortgage borrowers are occasionally over-optimistic, the central bank should be less responsive to inflation, more responsive to output, and slower to adjust the nominal policy interest rate. This optimal monetary policy rule dampens endogenous boom-bust cycles in house prices, but prolongs inflation target horizons due to weak policy reactions to inflation fluctuations after fundamental shocks.
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Bibliographic InfoPaper provided by Bank of Canada in its series Working Papers with number 09-32.
Length: 42 pages
Date of creation: 2009
Date of revision:
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Credit and credit aggregates; Financial stability; Inflation targets;
Find related papers by JEL classification:
- E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
- E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
This paper has been announced in the following NEP Reports:
- NEP-ALL-2009-12-05 (All new papers)
- NEP-CBA-2009-12-05 (Central Banking)
- NEP-DGE-2009-12-05 (Dynamic General Equilibrium)
- NEP-MAC-2009-12-05 (Macroeconomics)
- NEP-MON-2009-12-05 (Monetary Economics)
- NEP-URE-2009-12-05 (Urban & Real Estate Economics)
You can help add them by filling out this form.
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