Template-Type: ReDIF-Paper 1.0
Title: Falling Natural Rates, Rising Housing Volatility and the Optimal Inflation Target
Author-Name: Klaus Adam
Author-Email: adam@uni-mannheim.de
Author-Name: Oliver Pfäuti
Author-Email: oliver.pfaeuti@gess.unimannheim.de
Author-Name: Timo Reinelt
Author-Email: timo.reinelt@gess.unimannheim.de


Classification-JEL: E31, E44
Keywords: inflation target, real estate booms, natural rate

Abstract: The decline in natural interest rates in advanced economies over the past decades
has been accompanied by a signicant increase in the volatility of housing prices. We
show that the monetary policy implications of these macroeconomic trends depend|in
the presence of a lower-bound constraint on nominal rates|on the source of increased
housing price volatility. If housing price expectations are rational, increased housing
price volatility re
ects more volatile housing demand shocks. Under optimal monetary
policy, average in
ation then increases only minimally, as average natural rates fall and
housing shocks become more volatile. Instead, if housing price volatility is partly due to
speculative housing price beliefs, as suggested by survey data, then lower natural rates
endogenously trigger larger 
uctuations in subjective housing price beliefs and housing
prices. A belief-driven increase in housing price volatility causes also the natural rate of
interest to become more volatile. This exacerbates the lower-bound problem, especially
when average natural rates are low. Under optimal monetary policy, average in
ation
then rises much more strongly following a fall in natural rates, rationalizing larger
increases in the in
ation target.

Note: 
Length: 62
Creation-Date: 2020-11
Revision-Date: 
File-URL: https://www.crctr224.de/research/discussion-papers/archive/dp235
File-Format: application/pdf
Handle: RePEc:bon:boncrc:CRCTR224_2020_235