This paper aims to examine the controversial issue of the extent to which Federal Reserve monetary policy may have contributed to the recent housing crisis and subsequent adverse macroeconomic developments.
The authors develop a small model that facilitates OLS and VAR estimates of the critical period.
The empirical results support the claim of John B. Taylor and others who held that monetary policy was excessively stimulative in terms of the low fed funds rate 2002‐2005, but also support the view of Alan Greenspan and others that the linkages between short‐term rates, long‐term rates, and the housing market deteriorated during that decade.
The model includes the Taylor Rule, a housing equation, and a mechanism linking the two relationships. The empirical results support elements of the camp that blames monetary policy for the recent housing crisis, and elements of the opposing camp which limits policy culpability. Specifically, it suggests excessive monetary ease and a structural change (for which the Fed cannot be blamed) in the monetary policy‐housing market linkage that occurred prior to the crisis. The results also support long‐term, prior crisis, channels of influence that run from the state of the economy to fed funds rates to mortgage interest rates to housing prices. A return to normalcy in the housing market should be accompanied by the re‐establishment of these channels.
