The E¤ects of Housing Prices and Monetary Policy in a
Currency Union
Oriol Aspachs and Pau Rabanal
Caixa d’Estalvis i Pensions de Barcelona - International Monetary Fund

September 17, 2010.

Oriol Aspachs and Pau Rabanal

Monetary Policy
Caixaandd’Estalvis
Housingi Prices
Pensions de BarcelonaSeptember- International
17, 2010.
Monetary 1Fund/ 38 ()

Motivation
During the last two decades, the economic importance of the housing
sector has reached unprecedented levels, refreshing the debate on:
The role that the sector plays in amplifying economic volatility (Aoki
et. al., 2004; Iacoviello, 2005)
The drivers of housing cycles (Iacoviello and Neri, 2010)
The appropriate policy response (Mishkin, 2007; Basel III).
The debate has been of special interest in those countries that do not havetheir own monetary policy (EMU and …xed exchange rates).

Oriol Aspachs and Pau Rabanal

Monetary Policy
Caixaandd’Estalvis
Housingi Prices
Pensions de BarcelonaSeptember- International
17, 2010.
Monetary 2Fund/ 38 ()

Motivation
We focus on the case of Spain, where house prices and residential
investment went through a large boom since it joined the EMU:
Large decline of interest rates
Increased demand for housing due to demographic factors:
Immigration
Baby-boom generation

fuelled residential investment in particular, and also economic growth.
Question: Could the house price boom-and-bust cycle have been
avoided if Spain had not belonged to the EMU?
Oriol Aspachs and Pau Rabanal

Monetary Policy
Caixaandd’Estalvis
Housingi Prices
Pensions de BarcelonaSeptember- International
17, 2010.
Monetary 3Fund/ 38 ()

Motivation

Figure: Nominal house prices and interest rates.
Oriol Aspachs and Pau Rabanal

Monetary Policy
Caixaandd’Estalvis
Housingi Prices
Pensions de BarcelonaSeptember- International
17, 2010.
Monetary 4Fund/ 38 ()

Motivation

Figure: Residential Investment and interest rates.
Oriol Aspachs and Pau Rabanal

Monetary Policy
Caixaandd’Estalvis
Housingi Prices
Pensions de BarcelonaSeptember- International
17, 2010.
Monetary 5Fund/ 38 ()

Motivation

Figure: Demographic patterns

Oriol Aspachs and Pau Rabanal

Monetary Policy
Caixaandd’Estalvis
Housingi Prices
Pensions de BarcelonaSeptember- International
17, 2010.
Monetary 6Fund/ 38 ()

Motivation

Figure: Mortgage credit and the current account.
Oriol Aspachs and Pau Rabanal

Monetary Policy
Caixaandd’Estalvis
Housingi Prices
Pensions de BarcelonaSeptember- International
17, 2010.
Monetary 7Fund/ 38 ()

Plan of the talk1

Estimate a VAR with consumption, residential investment, GDP,
interest rates and house prices and study the IR functions to:- Interest rate shock- Housing Demand shock

Oriol Aspachs and Pau Rabanal

Monetary Policy
Caixaandd’Estalvis
Housingi Prices
Pensions de BarcelonaSeptember- International
17, 2010.
Monetary 8Fund/ 38 ()

Plan of the talk1

Estimate a VAR with consumption, residential investment, GDP,
interest rates and house prices and study the IR functions to:- Interest rate shock- Housing Demand shock2

Calibrate a New Keynesian DGE model:- of a small open economy in a currency area
- with durable goods.

Oriol Aspachs and Pau Rabanal

Monetary Policy
Caixaandd’Estalvis
Housingi Prices
Pensions de BarcelonaSeptember- International
17, 2010.
Monetary 8Fund/ 38 ()

Plan of the talk1

Estimate a VAR with consumption, residential investment, GDP,
interest rates and house prices and study the IR functions to:- Interest rate shock- Housing Demand shock2

Calibrate a New Keynesian DGE model:- of a small open economy in a currency area
- with durable goods.

3

Study the IR functions of the calibrated model to- a MP shock and a HD shock- compare them with those of the VAR.

Oriol Aspachs and Pau Rabanal

Monetary Policy
Caixaandd’Estalvis
Housingi Prices
Pensions de BarcelonaSeptember- International
17, 2010.
Monetary 8Fund/ 38 ()

Plan of the talk1

Estimate a VAR with consumption, residential investment, GDP,
interest rates and house prices and study the IR functions to:- Interest rate shock- Housing Demand shock2

Calibrate a New Keynesian DGE model:- of a small open economy in a currency area
- with durable goods.

3

Study the IR functions of the calibrated model to- a MP shock and a HD shock- compare them with those of the VAR.

4

The e¤ects of belonging to the EMU.

Oriol Aspachs and Pau Rabanal

Monetary Policy
Caixaandd’Estalvis
Housingi Prices
Pensions de BarcelonaSeptember- International
17, 2010.
Monetary 8Fund/ 38 ()

Plan of the talk1

Estimate a VAR with consumption, residential investment, GDP,
interest rates and house prices and study the IR functions to:- Interest rate shock- Housing Demand shock2

Calibrate a New Keynesian DGE model:- of a small open economy in a currency area
- with durable goods.

3

Study the IR functions of the calibrated model to- a MP shock and a HD shock- compare them with those of the VAR.

4

The e¤ects of belonging to the EMU.

5

The e¤ects of …nancial and labour market rigidities.
Oriol Aspachs and Pau Rabanal

Monetary Policy
Caixaandd’Estalvis
Housingi Prices
Pensions de BarcelonaSeptember- International
17, 2010.
Monetary 8Fund/ 38 ()

VAR estimation
We estimate:L

Yt = C + ∑ Aj Yt j + But
j =1

where Yt is a kx1 vector of observable variables, between 1997:01 to
2008:04, with:
1
2
3
4
5

real household consumption of …nal goods in Spain,
real residential investment in Spain,
real GDP in Spainthe reference 3-month interbank rate, andreal house prices in Spain.

We use the recursive identi…cation scheme of Christiano, Eichenbaum andEvans (1999) to identify the e¤ects of the interest rate shock.
We assume that housing prices respond contemporaneously to interest ratechanges and to demand shocks.
Oriol Aspachs and Pau Rabanal

Monetary Policy
Caixaandd’Estalvis
Housingi Prices
Pensions de BarcelonaSeptember- International
17, 2010.
Monetary 9Fund/ 38 ()

VAR, Impulse responses. Interest rate Shock

Oriol Aspachs and Pau Rabanal

Monetary Policy
Caixaandd’Estalvis
Housingi Prices
Pensions de Barcelona
September- International
17, 2010.
Monetary10Fund/ 38 ()

VAR, Impulse responses functions. Housing demand shock

Oriol Aspachs and Pau Rabanal

Monetary Policy
Caixaandd’Estalvis
Housingi Prices
Pensions de Barcelona
September- International
17, 2010.
Monetary11Fund/ 38 ()

VAR: Robustness exercises

1

Include HICP in‡ation and real GDP growth in the euro area tocontrol for endogenous response of euro area monetary policy.

2

Extend the sample period to 1980-2008.

3

Introduce sign restrictions as in Jarocinski and Smets (2008),
Cardarelli et al (2009)–> The main message does not change.

Oriol Aspachs and Pau Rabanal

Monetary Policy
Caixaandd’Estalvis
Housingi Prices
Pensions de Barcelona
September- International
17, 2010.
Monetary12Fund/ 38 ()

Plan of the talk1

Estimate a VAR with consumption, residential investment, GDP,
interest rates and house prices and study the IR functions to:- Interest rate shock- Housing demand shock2

Calibrate a New Keynesian DGE model:- of a small open economy in a currency area
- with durable goods.

3

Study the IR functions of the calibrated model to- a MP shock and a HD shock- compare them with those of the VAR.

4

The e¤ects of belonging to the EMU.

5

The e¤ects of …nancial and labour market rigidities.
Oriol Aspachs and Pau Rabanal

Monetary Policy
Caixaandd’Estalvis
Housingi Prices
Pensions de Barcelona
September- International
17, 2010.
Monetary13Fund/ 38 ()

The model
The theoretical framework consists of a DGE 2 country 2 sector model in asingle currency area where:
The countries are of size n and 1n.

Each of them produces durable goods, D, and nondurable goods, C ,under monopolistic competition and nominal (price and wage)
rigidities.
It is assumed that only the nondurable goods are tradable.
Two shocks: a durables (housing) demand shock (HD), a monetary
policy shock (MP)

Oriol Aspachs and Pau Rabanal

Monetary Policy
Caixaandd’Estalvis
Housingi Prices
Pensions de Barcelona
September- International
17, 2010.
Monetary14Fund/ 38 ()

The model: Households
Each household j in the home country maximizes:

E0

8
>
<∞

∑
>
: t =026βt 4γ log(Ctj

εCt 1 ) + (1jγ)ξ D
t log (Dt )consumption of nondurables index:"

Ctj = τ1
ιC

CHj ,t

ιC 1
ιC

+ (1

τ)

1
ιC

CFj ,tιC 1
ιC# ι ιC 1

39
>
=
7
(1)
5
>
1+η
;

Ljt

1 +η

C

, where ιC > 0 (2)imperfect substitutability of labor supply across sectors (Iacoviello andNeri, 2010):
Ljt =

α

ιL

LCt ,j1 + ιL

Oriol Aspachs and Pau Rabanal

+ (1

α)

ιL

,j
LD
t

1 + ιL1
1 + ιL, where ιL > 0 (3)Monetary Policy
Caixaandd’Estalvis
Housingi Prices
Pensions de Barcelona
September- International
17, 2010.
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The model: Households

Budget constraint:
PtC Ctj + PtD ItDj + PtA Ajt + Btj
R̃t 1 Btj 1 +,j
WtC LCt ,j
WtD LDt++ RtA + PtA Ajt 1 + Πjt
C
D
Xt
Xt

(4)

Domestic interest rate and the union-wide interest rate are related asfollows:
R̃t = Rt

Oriol Aspachs and Pau Rabanalϑ exp ψ

Bt
Pt Yt

B
PY

1

(5)

Monetary Policy
Caixaandd’Estalvis
Housingi Prices
Pensions de Barcelona
September- International
17, 2010.
Monetary16Fund/ 38 ()

The model: Households

We assume that the law of motion of the housing stock evolves as follows:
!#
"
D ,j
I
t
Dtj = (1 δ)Dtj 1 + 1 S
ItD ,j(6)
ItD ,j1
Following Christiano, Eichenbaum, and Evans (2005), we introduce anadjustment cost function, S (.), which is convex (i.e. S 00 () > 0).
This allows the model to generate hump-shaped responses of residential
investment to shocks. Short-cut for time-to-build.

Oriol Aspachs and Pau Rabanal

Monetary Policy
Caixaandd’Estalvis
Housingi Prices
Pensions de Barcelona
September- International
17, 2010.
Monetary17Fund/ 38 ()

The model: Labor supply and wage setting
Nominal wage stickiness is introduced as in Smets and Wouters (2007)
and Iacoviello and Neri (2010):

ω Ct

ω Ct 1 + ∆ptC

+κ C ,Wct

ϕC ,W ∆ptC 1 = βEt ω Ct+1

εct 1
+ [( ϕ1 ει)α + ι] ltC + ( ϕω Ct + ∆ptC+1
ι)(1

α)ltD

ϕC ,W ∆ptC
ω Ct

(7)

and

ωD
t

C
ωD
t 1 + ∆pt

+κ D ,Wct
1

ϕD ,W ∆ptC 1 = βEt ω D
t +1

εct 1
+ [( ϕε

Oriol Aspachs and Pau Rabanal

ι)(1

C
ωD
t + ∆pt +1α) + ι] ltD + ( ϕι)αltC

ϕD ,W ∆ptC
ωD
t

(8)

Monetary Policy
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Housingi Prices
Pensions de Barcelona
September- International
17, 2010.
Monetary18Fund/ 38 ()

The model: Households

The allocation of expenditures between home and foreign-produced goods
is:
ιC
PH ,t
Ct
(9)
CH ,t = τPtC
CF ,t = (1

τ)

PF ,t
PtC

ιC

Ct .

(10)

The price index for non-durables is (the CPI):
PtC

1 ιC

h
= τ (PH ,t )1 ιC + (1Oriol Aspachs and Pau Rabanaliτ ) (PF ,t )1 ιC .

(11)

Monetary Policy
Caixaandd’Estalvis
Housingi Prices
Pensions de Barcelona
September- International
17, 2010.
Monetary19Fund/ 38 ()

The model: Producers

Suppliers behave as competitive monopolists when selling theirproducts, subject to a Calvo-type restriction with backward
indexation. This gives raise to NK Phillips Curves in both sectors.
The production function is linear in labor in the nondurable sector. It
is Cobb-Douglas in labor and land in the durable (housing) sector.

Oriol Aspachs and Pau Rabanal

Monetary Policy
Caixaandd’Estalvis
Housingi Prices
Pensions de Barcelona
September- International
17, 2010.
Monetary20Fund/ 38 ()

Closing the model

Monetary policy is conducted with a Taylor rule:
Rt = R̄ 1 γR Rt R 1 (
γ

ΠEMU
t
)(1 γR )γπ exp(εm
t )
Π̄EMU

(12)

where ΠEMU
.is the weighted in‡ation rate in the currency union.
tOriol Aspachs and Pau Rabanal

Monetary Policy
Caixaandd’Estalvis
Housingi Prices
Pensions de Barcelona
September- International
17, 2010.
Monetary21Fund/ 38 ()

Calibration

n
α
1 τ
1 τ
κ
σC , σDβδηTable 1: Calibrated Parameters of the Model
Size of Spain inside the EMU
Share of the nondurable sector in the GDP
Fraction of EMU imports consumed in Spain
Fraction of Spain imports goods consumed in the EMU
Debt elasticity of the domestic interest rate
Elasticity of substitution between intermediate goods
Discount factor
Depreciation rate of housing stock
Labor supply elasticity

Oriol Aspachs and Pau Rabanal

0.1
0.9
0.15
0.015
0.02
10
0.99
0.025
0.9

Monetary Policy
Caixaandd’Estalvis
Housingi Prices
Pensions de Barcelona
September- International
17, 2010.
Monetary22Fund/ 38 ()

Calibration
ιC
ιL
γ
ψ
θC
θD
φC
φD
θ C ,W , θ D ,W
φC ,W , φD ,WγπγRTable 1: Calibrated Parameters of the Model
Elasticity of subs. between goods
Costly labor reallocation
Share of non-durable consumption in the CPI
Investment adjustment costs
Calvo lottery for the non-durable sector, prices
Calvo lottery for the durable sector, prices
Price indexation, non-durables
Price indexation, durables
Calvo lottery for wages
Wage indexation
In‡ation parameter of the Taylor ruleInterest rate smoothing parameter of the Taylor rule

4.4
1.3
0.82
0.3
0.87
0.34
0.5
0.7
0.75
1
1.25
0.77

Mostly taken from a companion paper of ours where we estimated thismodel with Bayesian methods (Aspachs-Bracons and Rabanal, 2010).
Oriol Aspachs and Pau Rabanal

Monetary Policy
Caixaandd’Estalvis
Housingi Prices
Pensions de Barcelona
September- International
17, 2010.
Monetary23Fund/ 38 ()

Plan of the talk1

Estimate a VAR with consumption, residential investment, GDP,
interest rates and house prices and study the IR functions to:- Interest rate shock- Housing demand shock2

Calibrate a New Keynesian DGE model:- of a small open economy in a currency area
- with durable goods.

3

Study the IR functions of the calibrated model to- a MP shock and a HD shock- compare them with those of the VAR.

4

The e¤ects of belonging to the EMU.

5

The e¤ects of …nancial and labour market rigidities.
Oriol Aspachs and Pau Rabanal

Monetary Policy
Caixaandd’Estalvis
Housingi Prices
Pensions de Barcelona
September- International
17, 2010.
Monetary24Fund/ 38 ()

IR functions: Monetary policy shock

Oriol Aspachs and Pau Rabanal

Monetary Policy
Caixaandd’Estalvis
Housingi Prices
Pensions de Barcelona
September- International
17, 2010.
Monetary25Fund/ 38 ()

IR functions: Housing preference shock

Oriol Aspachs and Pau Rabanal

Monetary Policy
Caixaandd’Estalvis
Housingi Prices
Pensions de Barcelona
September- International
17, 2010.
Monetary26Fund/ 38 ()

Plan of the talk1

Estimate a VAR with consumption, residential investment, GDP,
interest rates and house prices and study the IR functions to:- Interest rate shock- Housing demand shock2

Calibrate a New Keynesian DGE model:- of a small open economy in a currency area
- with durable goods.

3

Study the IR functions of the calibrated model to- a MP shock and a HD shock- compare them with those of the VAR.

4

The e¤ects of belonging to the EMU.

5

The e¤ects of …nancial and labour market rigidities.
Oriol Aspachs and Pau Rabanal

Monetary Policy
Caixaandd’Estalvis
Housingi Prices
Pensions de Barcelona
September- International
17, 2010.
Monetary27Fund/ 38 ()

The e¤ects of belonging to the EMU
The goal: study how would a small open economy react in a two country
model when faced with housing demand shocks.
We introduce:
1 Taylor rules for both countries,
rt
rt

2

= γR rt 1 + (1= γR rt 1 + (1γR )γD ∆ptD

γR )γπ ∆ptC .

(13)
(14)

An uncovered interest rate parity condition,rt3γR )γπ ∆ptC + (1rt = Et nert +1

nert

κbt

(15)

Producer currency pricing for imports and exports of non-durable
goods, as in Lubik and Schorfheide (2006).
Oriol Aspachs and Pau Rabanal

Monetary Policy
Caixaandd’Estalvis
Housingi Prices
Pensions de Barcelona
September- International
17, 2010.
Monetary28Fund/ 38 ()

The e¤ects of belonging to the EMU. Housing preference
shock

Oriol Aspachs and Pau Rabanal

Monetary Policy
Caixaandd’Estalvis
Housingi Prices
Pensions de Barcelona
September- International
17, 2010.
Monetary29Fund/ 38 ()

Plan of the talk1

Estimate a VAR with consumption, residential investment, GDP,
interest rates and house prices and study the IR functions to:- Interest rate shock- Housing demand shock2

Calibrate a New Keynesian DGE model:- of a small open economy in a currency area
- with durable goods.

3

Study the IR functions of the calibrated model to- a MP shock and a HD shock- compare them with those of the VAR.

4

The e¤ects of belonging to the EMU.

5

The e¤ects of …nancial and labour market rigidities.
Oriol Aspachs and Pau Rabanal

Monetary Policy
Caixaandd’Estalvis
Housingi Prices
Pensions de Barcelona
September- International
17, 2010.
Monetary30Fund/ 38 ()

Robustness checks: The e¤ects of …nancial frictions

We assume that a fraction 1

λ of agents:

B

are more impatient: β < βStB ,j(1χ)DtB ,j PtD

Financially constraint households can borrow from unconstrainedhouseholds within a country only, while unconstrained households canborrow and lend at the national and international level.

Oriol Aspachs and Pau Rabanal

Monetary Policy
Caixaandd’Estalvis
Housingi Prices
Pensions de Barcelona
September- International
17, 2010.
Monetary31Fund/ 38 ()

IR functions: the role of …nancial frictions. Monetary
policy shock.

Oriol Aspachs and Pau Rabanal

Monetary Policy
Caixaandd’Estalvis
Housingi Prices
Pensions de Barcelona
September- International
17, 2010.
Monetary32Fund/ 38 ()

IR functions: the role of …nancial frictions. Housing
preference shock

Oriol Aspachs and Pau Rabanal

Monetary Policy
Caixaandd’Estalvis
Housingi Prices
Pensions de Barcelona
September- International
17, 2010.
Monetary33Fund/ 38 ()

The role of labor market frictions.

We analyze how the response to both shocks changes when:1

we remove wage stickiness and indexation,
θ C ,W = θ D ,W = φC ,W = φD ,W = 0

2

we remove the labor reallocation cost,ιL = 0

Oriol Aspachs and Pau Rabanal

Monetary Policy
Caixaandd’Estalvis
Housingi Prices
Pensions de Barcelona
September- International
17, 2010.
Monetary34Fund/ 38 ()

The role of labor market frictions. Monetary policy shock.

Oriol Aspachs and Pau Rabanal

Monetary Policy
Caixaandd’Estalvis
Housingi Prices
Pensions de Barcelona
September- International
17, 2010.
Monetary35Fund/ 38 ()

The role of labor market frictions. Housing preference
shock

Oriol Aspachs and Pau Rabanal

Monetary Policy
Caixaandd’Estalvis
Housingi Prices
Pensions de Barcelona
September- International
17, 2010.
Monetary36Fund/ 38 ()

Concluding Remarks

1. We have presented a model capable of replicating the VAR evidence
since Spain joined the EMU.
2. Labor market rigidities are necessary to obtain the right comovement
between the two sectors of the economy. Financial frictions play a minor
role in the propagation mechanism.
3. Policy message: If Spain had not belonged to the EMU theboom-and-bust cycle in housing prices between 1996-2007 could not havebeen avoided by using monetary policy. Using higher nominal interest rates
would have created a recession in the rest of the economy. Similar results
for the U.S. appear in Dokko et al. (2009).

Oriol Aspachs and Pau Rabanal

Monetary Policy
Caixaandd’Estalvis
Housingi Prices
Pensions de Barcelona
September- International
17, 2010.
Monetary37Fund/ 38 ()

Concluding Remarks

4. Fatás et al. (2009) and Dokko et al. (2009) study the relationshipbetween the stance of monetary policy (proxied by Taylor rule residuals)
and real house price increases during 2002-2006. The cross-country
relationship between the two variables is statistically weak.
5. Future direction: macro-prudential policies. Kannan, Rabanal andScott (2009), Angeloni and Faia (2010), Angelini, Neri, Panetta (2010),
BIS (2010). Question: How much bite will they have? Regulatory
arbitrage in a currency union?

Oriol Aspachs and Pau Rabanal

Monetary Policy
Caixaandd’Estalvis
Housingi Prices
Pensions de Barcelona
September- International
17, 2010.
Monetary38Fund/ 38 ()