What Should Central Banks do about Real Estate Prices?
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Wharton Financial Institutions Center; 2011/29
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ALLEN, Franklin, CARLETTI, Elena, What Should Central Banks do about Real Estate Prices?, Wharton Financial Institutions Center, 2011/29 - https://hdl.handle.net/1814/15975
Abstract
Many central banks use inflation targeting as the basis for their monetary policy. The
underlying notion of this approach is that there are no long term benefits in terms of reduced
unemployment from having inflation. The traditional view is that monetary policy should focus
on controlling consumer price inflation. Asset prices should only be considered in as much as
they feed into consumer prices and short term output. However, Reinhart and Rogoff (2009)
provide considerable evidence that collapses in real estate prices are the main cause of many
financial crises. In this paper we consider how inflation targeting should be adapted to account
for real estate prices. We develop a theory of real estate bubbles and show how these can be
triggered by low interest rates. It is suggested that in small homogenous countries like Sweden
interest rates can be used to prevent bubbles. In large economies this may not be desirable
because bubbles tend to be regional. In all economies macroprudential policies have a role to
play in preventing and pricking bubbles. However, there is an important issue of how effective
they will be in practice.