DP8804 Monetary Policy Transmission in a Model with Animal Spirits and House Price Booms and Busts

Author(s): Peter Bofinger, Sebastian Debes, Johannes Gareis, Eric Mayer
Publication Date: January 2012
Keyword(s): animal spirits, housing markets, monetary policy
JEL(s): D83, E32, E52
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=8804

Can monetary policy trigger pronounced boom-bust cycles in house prices and create persistent business cycles? We address this question by building heuristics into an otherwise standard DSGE model. As a result, monetary policy sets off waves of optimism and pessimism ('animal spirits') that drive house prices, which, in turn, have strong repercussions on the business cycle. We compare our findings to a standard model with rational expectations by means of impulse responses. We suggest that a standard Taylor rule is not well-suited to maintain macroeconomic stability. Instead, an augmented rule that incorporates house prices is shown to be superior.