Housing Bubbles and Monetary Policy: A Reassessment

Abstract

This study contributes to the ongoing debate over the causes of housing bubbles. The argument that excessively low interest rates were responsible for the rapid increase in house prices over the last decade has received considerable attention in the literature. However, few papers have attempted to quantify the extent of house price overvaluation in countries that have seen housing booms and busts, in addition to quantifying the looseness of monetary policy. For a sample of 10 OECD countries, we estimate fundamental house prices using demand and supply side characteristics of the housing market. This is supplemented with analysis of price to rent ratios and fundamental price to rent ratios. Loose monetary policy is defined as the deviation of the shortterm interest rate from the rate which the Taylor rule would prescribe. The empirical results suggest that for some countries deviations from the Taylor rule played a role in the surge in house prices and that a monetary policy stance less discretionary and more closely aligned with a Taylor rule could curtail some of the imbalance in the housing market.