Discussion paper

DP12937 Leaning Against Housing Prices as Robustly Optimal Monetary Policy

We analytically characterize optimal monetary policy for a New
Keynesian model with a housing sector. If one supposes that the private sector
has rational expectations about future housing prices and inflation, optimal
monetary policy can be characterized without making reference to housing price
developments: commitment to a “target criterion” that refers only to inflation and
the output gap is optimal, as in the standard model without a housing
sector. But when a policymaker seeks to choose a policy that is robust to potential departures of private
sector expectations from model-consistent ones, then the optimal target criterion
must also depend on housing prices. In the empirically realistic case where
housing is subsidized and where monopoly power causes output to fall short of
its optimal level, the robustly optimal target criterion requires the central
bank to “lean against” housing prices: following unexpected housing price
increases, policy should adopt a stance that is projected to undershoot its
normal targets for inflation and the output gap, and similarly aim to
overshoot those targets in the case of unexpected declines in housing prices.
The robustly optimal target criterion does not require that policy
distinguish between “fundamental” and “non-fundamental” movements in housing


Adam, K and M Woodford (2018), ‘DP12937 Leaning Against Housing Prices as Robustly Optimal Monetary Policy‘, CEPR Discussion Paper No. 12937. CEPR Press, Paris & London. https://cepr.org/publications/dp12937