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The effect of monetary policy on house price inflation: A factor augmented vector autoregression (FAVAR) approach

  • Rangan Gupta
  • Alain Kabundi

Purpose – This paper seeks to assess the impact of monetary policy on house price inflation for the nine census divisions of the US economy. Design/methodology/approach – A factor-augmented VAR (FAVAR) model is estimated using a large data set comprising of 126 quarterly series over the period 1976:01 to 2005:02. Findings – Overall, the results of this investigation show that house price inflation responds negatively to a positive monetary policy shock, suggesting that the framework does not experience the widely observed price puzzle encountered while analyzing monetary policy shocks with standard sized VARs. Research limitations/implications – The paper only considers house price inflation and ignores other housing market variables. Moreover, given the recent economy-wide decline in the house price growth rates, it would be worthwhile to update the data set to a more recent period, to capture the possible breakdown in the relationship of house prices with fundamentals driving the market. Practical implications – The results based on the impulse response functions indicate that, in general, house price inflation responds negatively to monetary policy shock, but the responses are heterogeneous across the census divisions. In addition, the findings suggest, in particular, the importance of South Atlantic, East South Central, West South Central, Mountain and the Pacific divisions in shaping the dynamics of US house price inflation. Originality/value – To the best of one's knowledge, this is the first paper to analyze the effect of monetary policy on house price inflation in the nine census divisions of the US economy using a FAVAR model.

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Article provided by Emerald Group Publishing in its journal Journal of Economic Studies.

Volume (Year): 37 (2010)
Issue (Month): 6 (September)
Pages: 616-626

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Handle: RePEc:eme:jespps:v:37:y:2010:i:6:p:616-626
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  1. Sonali Das & Rangan Gupta & Alain Kabundi, 2009. "The Blessing Of Dimensionality In Forecasting Real House Price Growth In The Nine Census Divisions Of The Us," Working Papers 200902, University of Pretoria, Department of Economics.
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  12. Matteo Iacoviello & Raoul Minetti, 2002. "Financial Liberalisation and the Sensitivity of House Prices to Monetary Policy: Theory and Evidence," Boston College Working Papers in Economics 538, Boston College Department of Economics.
  13. Bernanke, Ben & Gertler, Mark, 1995. "Inside the Black Box: The Credit Channel of Monetary Policy Transmission," Working Papers 95-15, C.V. Starr Center for Applied Economics, New York University.
  14. Lutz Kilian, 1998. "Small-Sample Confidence Intervals For Impulse Response Functions," The Review of Economics and Statistics, MIT Press, vol. 80(2), pages 218-230, May.
  15. Ndahiriwe Kasai & Rangan Gupta, 2010. "Financial Liberalization and the Effectiveness of Monetary Policy on House Prices in South Africa," The IUP Journal of Monetary Economics, IUP Publications, vol. 0(4), pages 59-74, November.
  16. Jonathan McCarthy & Richard Peach, 2002. "Monetary policy transmission to residential investment," Economic Policy Review, Federal Reserve Bank of New York, issue May, pages 139-158.
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  19. Matteo Iacoviello, 2002. "House Prices and Business Cycles in Europe: a VAR Analysis," Boston College Working Papers in Economics 540, Boston College Department of Economics.
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