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How Should Monetary Policy Respond to Housing Inflation?

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Abstract

A persistent rise in rents has kept inflation above target in many advanced economies. Optimal policy in the standard New Keynesian (NK) model requires policy to stabilize housing inflation. We argue that the basic architecture of the NK model—that excess demand is always satisfied by producers—is inappropriate for the housing market, and we develop a matching framework that allows for demand rationing. Our findings indicate that the optimal response to a housing demand shock is to stabilize inflation in the non-housing sector while disregarding housing inflation. Our results hold exactly in a version of the model with costless search and quantitatively in a version with housing search costs calibrated to match US data on housing tenure, vacancy rates, and the size of the real estate sector.

Suggested Citation

  • Javier Bianchi & Alisdair McKay & Neil Mehrotra, 2024. "How Should Monetary Policy Respond to Housing Inflation?," Working Papers 808, Federal Reserve Bank of Minneapolis.
    • Handle: RePEc:fip:fedmwp:99022
    DOI: 10.21034/wp.808
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    References listed on IDEAS

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    1. Hassan Afrouzi & Saroj Bhattarai, 2023. "Inflation and GDP Dynamics in Production Networks: A Sufficient Statistics Approach," NBER Working Papers 31218, National Bureau of Economic Research, Inc.
    2. Aoki, Kosuke, 2001. "Optimal monetary policy responses to relative-price changes," Journal of Monetary Economics, Elsevier, vol. 48(1), pages 55-80, August.
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    Cited by:

    1. Joel P. Flynn & George Nikolakoudis & Karthik A. Sastry, 2026. "Pricing and Production Without the Invisible Hand," Cowles Foundation Discussion Papers 2501, Cowles Foundation for Research in Economics, Yale University.
    2. Hedlund, Aaron & Larkin, Kieran & Mitman, Kurt & Ozkan, Serdar, 2025. "Mortgage Market Structure and the Transmission of Monetary Policy During the Great Inflation," IZA Discussion Papers 17971, IZA Network @ LISER.
    3. Daniel Albuquerque & Thomas Lazarowicz & Jamie Lenney, 2025. "Monetary transmission through the housing sector," Bank of England working papers 1115, Bank of England.

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    JEL classification:

    • E24 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
    • E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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