Did the FED contribute to the housing price bubble? Evidence from Taylor Rule Deviations

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Did the FED contribute to the housing price bubble? Evidence from Taylor Rule Deviations

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Title: Did the FED contribute to the housing price bubble? Evidence from Taylor Rule Deviations
Author: Fitwi, Abrar
Abstract: I test the effects of two competing forces behind the housing price bubble that preceded the recent financial crisis. Using deviations from the Taylor Rule as a measure for whether target fed funds rates were low relative to the Fed’s earlier behavior based on existing economic performance and with due consideration given to issues of stationarity and optimal lag length, I find that the role of low target fed funds rates, but not international capital inflows to the U.S., was significant in explaining housing prices. My evidence supports the monetary policy based explanation for the housing price bubble. To the contrary, I find little evidence supporting the global saving glut hypothesis. The result is robust to various additional tests such as Granger causality and other VAR methods. This evidence has an important implication on the current and future Fed policies, suggesting there might be an important cost associated with “easy” monetary policy.
URI: http://hdl.handle.net/2346/45374
Date: 2012-05

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