House prices, consumption, and monetary policy: a financial accelerator approach

Working papers set out research in progress by our staff, with the aim of encouraging comments and debate.
Published on 20 December 2002

Working Paper no. 169
Kosuke Aoki, James Proudman and Gertjan Vlieghe

There is a live debate about the role of house prices in the transmission mechanism of monetary policy. Do house prices merely reflect macroeconomic conditions, or are there important feedback effects from house prices to other economic variables? We consider a general equilibrium model where asymmetric information problems create frictions in credit markets used by households. In particular, we apply the financial accelerator mechanism of Bernanke, Gertler and Gilchrist to the household sector. In our economy, houses serve two purposes: they provide a stream of housing services to consumers and they serve as collateral to lower the agency costs related to borrowing. We show that under certain conditions this amplifies and propagates the effect of monetary policy shocks on housing investment, house prices and consumption. We also consider the effect of a structural change in credit markets that lowers the transaction costs of additional borrowing against housing equity. We show that such a change would increase the effect of monetary policy shocks on consumption, but would decrease the effect of monetary policy shocks on house prices and housing investment.

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