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Monetary Policy, Residential Investment, and Search Frictions: An Empirical and Theoretical Synthesis

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  • Kurt Graden Lunsford

Abstract

Using a factor-augmented vector autoregression (FAVAR), this paper shows that residential investment contributes substantially to GDP following monetary policy shocks. Further, it shows that the number of new housing units built, not changes in the sizes of existing or new housing units, drives residential investment fluctuations. Motivated by these results, this paper develops a dynamic stochastic general equilibrium (DSGE) model where houses are built in discrete units and traded through searching and matching. The search frictions transmit shocks to housing construction, making them central to producing fluctuations in residential investment. The interest rate spread between mortgages and risk-free bonds also transmits monetary policy to the housing market. Following monetary shocks, the DSGE model matches the FAVAR?s positive co-movement between nondurable consumption and residential construction spending. In addition, the FAVAR shows that the mortgage spread falls following an expansionary monetary shock, providing empirical support for the DSGE model?s monetary transmission mechanism.

Suggested Citation

  • Kurt Graden Lunsford, 2016. "Monetary Policy, Residential Investment, and Search Frictions: An Empirical and Theoretical Synthesis," Working Papers (Old Series) 1607, Federal Reserve Bank of Cleveland.
    • Handle: RePEc:fip:fedcwp:1607
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    More about this item

    Keywords

    Factor-augmented vector autoregression; interest rate spreads; monetary policy; residential investments; search theory;
    All these keywords.

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)
    • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General
    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
    • R31 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Real Estate Markets, Spatial Production Analysis, and Firm Location - - - Housing Supply and Markets

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