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Optimal Monetary Policy during Endogenous Housing-Market Boom-Bust Cycles

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  • Hajime Tomura

Abstract

This 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.

Suggested Citation

  • Hajime Tomura, 2009. "Optimal Monetary Policy during Endogenous Housing-Market Boom-Bust Cycles," Staff Working Papers 09-32, Bank of Canada.
  • Handle: RePEc:bca:bocawp:09-32
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    Cited by:

    1. Geoffrey Meen & Alexander Mihailov & Yehui Wang, 2016. "Endogenous UK Housing Cycles and the Risk Premium: Understanding the Next Housing Crisis," Economics & Management Discussion Papers em-dp2016-02, Henley Business School, Reading University.

    More about this item

    Keywords

    Credit and credit aggregates; Financial stability; Inflation targets;

    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

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