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The Effect of Monetary Policy on Housing Tenure Choice as an Explanation for the Price Puzzle

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Abstract

In this paper we provide an alternative explanation for the price puzzle (Sims 1992) based on the effect of monetary policy on housing tenure choice and the weight of the shelter component in overall CPI. In the presence of nominal or financial frictions, when interest rates increase, the real cost of owning a house increases, and this increase may make some people prefer to rent instead of buying. This change in consumption behavior increases the price of rents relative to other goods. Starting in 1983, homeownership costs are based on a measure of implied owner equivalent rent, which is calculated using observed house rents. This change implies that, directly and indirectly, prices in the rental market almost entirely command the shelter component of CPI, which weighs around 30% in the overall index. When we take these two pieces into account and use CPI net of shelter services as a measure of inflation, we obtain impulse responses of prices to a monetary contraction shock more in line with what is predicted by theory. In addition, our results also suggest that inflation is much less persistent than what is implied by analyses using a measure of inflation that includes shelter services. Our results pass a long list of robustness check exercises and compare well against other explanations of the price puzzle.

Suggested Citation

  • Daniel A. Dias & Joao B. Duarte, 2016. "The Effect of Monetary Policy on Housing Tenure Choice as an Explanation for the Price Puzzle," International Finance Discussion Papers 1171, Board of Governors of the Federal Reserve System (U.S.).
    • Handle: RePEc:fip:fedgif:1171
    DOI: 10.17016/IFDP.2016.1171
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    References listed on IDEAS

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    1. Uhlig, Harald, 2005. "What are the effects of monetary policy on output? Results from an agnostic identification procedure," Journal of Monetary Economics, Elsevier, vol. 52(2), pages 381-419, March.
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    4. Ben S. Bernanke & Jean Boivin & Piotr Eliasz, 2005. "Measuring the Effects of Monetary Policy: A Factor-Augmented Vector Autoregressive (FAVAR) Approach," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 120(1), pages 387-422.
    5. Henzel, Steffen & Hülsewig, Oliver & Mayer, Eric & Wollmershäuser, Timo, 2009. "The price puzzle revisited: Can the cost channel explain a rise in inflation after a monetary policy shock?," Journal of Macroeconomics, Elsevier, vol. 31(2), pages 268-289, June.
    6. Joao Bernardo Duarte & Daniel A. Dias, 2015. "Housing and Monetary Policy in the Business Cycle: What do Housing Rents have to Say?," 2015 Papers pdu385, Job Market Papers.
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    8. Sims, Christopher A., 1992. "Interpreting the macroeconomic time series facts : The effects of monetary policy," European Economic Review, Elsevier, vol. 36(5), pages 975-1000, June.
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    1. Joao Bernardo Duarte & Daniel A. Dias, 2015. "Housing and Monetary Policy in the Business Cycle: What do Housing Rents have to Say?," 2015 Papers pdu385, Job Market Papers.

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    More about this item

    Keywords

    Price puzzle; Housing tenure choice; Monetary policy; SVAR;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • R21 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Household Analysis - - - Housing Demand

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