The Effects of Housing Prices and Monetary Policy in a Currency Union

The recent boom-and-bust cycle in housing prices has refreshed the debate on the drivers of housing cycles as well as the appropriate policy response. We analyze the case of Spain, where housing prices have soared since it joined the EMU. We present evidence based on a VAR model, and we calibrate a New Keynesian model of a currency area with durable goods to explain it. We find that labor market rigidities provide stronger amplification effects to all type of shocks than financial frictions do. Finally, we show that when the central bank reacts to house prices, the non-durable sector suffers an important contraction. As a result, the boom-and-bust cycle would not have been avoided if Spain had remained outside the EMU during the 1996-2007 period.Housing;Economic models;External shocks;Housing prices;Interest rates;Labor markets;monetary policy, inflation, monetary economics, central bank, price level, nominal interest rate, inflation targeting, monetary authority, monetary fund, relative price, monetary union, monetary shock, inflation targeting regime, terms of trade, relative prices, inflation rate, monetary authorities, monetary transmission, optimal monetary policy, monetary shocks, monetary policy rule, price inflation, increase in interest rates, monetary autonomy, monetary policy autonomy, monetary policy decisions, real wages, inflation target, real variables, expansionary monetary policy, gdp deflator, monetary policy independence, monetary policy regime, real interest rates, contractionary monetary policy