The Effects of Housing Prices and Monetary Policy in a Currency Union
53 Pages Posted: 1 Feb 2011
Date Written: Janurary 2011
Abstract
The recent boom-and-bust cycle in housing prices has refreshed the debate on the drivers of housing cycles as well as the appropriate policy response. We analyze the case of Spain, where housing prices have soared since it joined the EMU. We present evidence based on a VAR model, and we calibrate a New Keynesian model of a currency area with durable goods to explain it. We find that labor market rigidities provide stronger amplification effects to all type of shocks than financial frictions do. Finally, we show that when the central bank reacts to house prices, the non-durable sector suffers an important contraction. As a result, the boom-and-bust cycle would not have been avoided if Spain had remained outside the EMU during the 1996-2007 period.
Keywords: Demand, Economic models, European Economic and Monetary Union, External shocks, Housing, Housing prices, Interest rates, Labor markets, Monetary policy, Spain
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