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Title:Optimal monetary policy during endogenous housing-market boom-bust cycles PDF Logo
Authors:Tomura, Hajime
Issue Date:2009
Series/Report no.:Bank of Canada Working Paper 2009,32
Abstract:This paper uses a small-open economy model for the Canadian economy to examine the optimal Taylor-type monetary policy rule that stabilizes output and inflation in an environment where endogenous boom-bust cycles in house prices can occur. The model shows that boom-bust cycles in house prices emerge when credit-constrained mortgage borrowers expect that future house prices will rise and this expectation is neither shared by savers nor realized ex-post. These boom-bust cycles replicate the stylized features of housing-market boom-bust cycles in industrialized countries. In an environment where mortgage borrowers are occasionally over-optimistic, the central bank should be less responsive to inflation, more responsive to output, and slower to adjust the nominal policy interest rate. This optimal monetary policy rule dampens endogenous boom-bust cycles in house prices, but prolongs inflation target horizons due to weak policy reactions to inflation fluctuations after fundamental shocks.
Subjects:Credit and credit aggregates
Financial stability
Inflation targets
JEL:E44
E52
Document Type:Working Paper
Appears in Collections:Bank of Canada Working Papers

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