Should the Central Bank Be Concerned About Housing Prices?

Housing is an important component of the consumption basket. Since both rental prices and goods prices are sticky, the literature suggests that optimal monetary policy should stabilize both types of prices, with the optimal weight on rental inflation proportional to the housing expenditure share. In a two-sector DSGE model with sticky rental prices and goods prices, however, we find that the optimal weight on rental inflation in the Taylor rule is small—much smaller than that implied by the housing expenditure share. We show that the asymmetry in policy responses to rent inflation versus goods inflation stems from the asymmetry in factor intensity between the two sectors. Date: December 3, 2010. Jeske: Mellon Capital Management, [email protected]; Liu: Federal Reserve Bank of San Francisco, [email protected]. We are grateful to Alex Wolman, Tao Zha, an editor, and two anonymous referees for helpful comments. The views expressed herein are those of the authors and do not necessarily reflect the views of the Federal Reserve Bank of San Francisco or the Federal Reserve System. 1 SHOULD THE CENTRAL BANK BE CONCERNED ABOUT HOUSING PRICES? 2