Tuesday, June 30, 2009

Housing market boom-bust cycles and monetary policy

The preceding boom and current bust in the housing market have been blamed on the false expectations of market participants that house prices would always increase. While this expectation was historically correct (the Case-Shiller for the United States never decreased until now), this is obviously wrong for local markets. So, it cannot be true that everyone would buy the myth of ever increasing house prices. Can boom and bust then still happen?

Hajime Tomura shows that it is possible even when market participants have heterogeneous beliefs. And these fluctuations also impact the rest of the economy, just like we observe now. The model is rich enough to show that a monetary policy that is actively fighting inflation exacerbates these boom-bust cycles. So maybe it is a good idea that many central banks are putting aside inflation considerations for the moment.


De Reyna said...

Since money isn't created by the government in America in order to create additional money needed by the economy people must borrow more and more money. This is a good site to explain this. Basically increasingly large loans for homes is an important way in which money is created. If money creation was decoupled from loans We'd be much less likely to have housing bubbles in the future.

Anonymous said...

Money does not need to be created to grow the economy. If fact inflation has eaten away a lot of the value of our money. Somewhere around 90% since the creation of the Federal Reserve in 1913. The moderate (1-5%) inflation we generally experience over time is precisely the Fed creating additional money - inflating the money supply.


The (official?) policy of the Fed is to maintain sustained moderate inflation. You can read more about money here (http://www.amazon.com/Monetary-History-United-States-1867-1960/dp/0691003548) or read Rothbard on inflation here http://mises.org/money/3s2.asp

Like many things once you scratch the surface it gets complex.

Anonymous said...

On the same issue, see this interesting working paper:
The housing price boom of the late ’90s: did inflation targeting matter?