Leaning Against the Wind in the Housing Market

Conducting monetary policy in a rules-based, rather than discretionary framework is central to much of the success central banks have had in stabilizing the economy in the last decades. Taylor rules offer a simple, straight-forward way of describing such a rules-based approach. This paper estimates and interprets different versions of the Taylor rule for the Unites States over the period from 2000 to 2013 using a GMM approach. Overall the Fed seems to have followed its dual mandate of stabilizing inflation and unemployment reasonably well prior to the crisis, even though the Fed's reaction to changes in the inflation rate is relatively muted. A model is then constructed to test alternative hypotheses and counter-factual scenarios, specifically the effects of a Taylor rule that includes a housing price index as an additional target variable. The model indicates that a symmetric target would not, on average, slow down economic growth yet help stabilize both more general economic indicators as well as the housing market. Particularly if causality runs from developments in the housing market to economic growth it would seem prudent to pay explicit attention to the former when conducting monetary policy as standard flexible inflation targeting would be insufficient to ensure overall economic stability in the presence of bubbles in this market.