This paper gives a selective review of the literature on monetary policy and real estate prices, including both empirical and theoretical contributions. The literature is rapidly evolving and there is considerable debate, particularly about whether monetary policy should play a role in forestalling dangerous real estate bubbles, even if the monetary authorities can recognize them.
There is no question that too much of the academic literature on monetary policy is built on models with perfect financial markets, which essentially assume away any debt catastrophes associated with real estate crashes. The small literature that does incorporate financial frictions mainly does so in a way that creates second-order distortions, but does not yield the kind of catastrophic discontinuous collapses that have been witnessed periodically in practice.
This paper surveys recent research that attempts to incorporate financial frictions and bubbles, and to allow for a possible role for monetary policy in exacerbating leverage cycles. We discuss this literature in sections 3-6 of the paper. Section 7 discusses the view that properly tuned macro prudential regulation policy can relieve monetary policy of any need to focus on real estate prices except as a helpful indicator in predicting near and medium-term inflation and unemployment.
Our read of the literature is that it is probably dangerous to adopt any extreme position. Even if macro-prudential regulation is the first line of defense, it can be subject to political pressures that leave significant vulnerabilities if monetary policy is not vigilant. Fundamentally, because of the central banks role as lender of last resort, macro-prudential policy and monetary policy have to be inter-linked.
In section 2 of the paper, we give an introduction to some related empirical literature, underscoring both the importance of being alert to real estate bubbles, while at the same time showing how difficult they can be to quantify in practice.
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Asset Prices, Financial Stability and Monetary Policy
