Institute for Empirical Rearch in Economics
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University of Zurich
Working Paper Series
ISSN 1424-0459
Working Paper No. 361
Ensuring Financial Stability: Financial Structure and the Impact of Monetary Policy on Ast Prices
Katrin Asnmacher-Wesche and Stefan Gerlach
March 2008
Revid draft
Ensuring Financial Stability: Financial Structure and the
Impact of Monetary Policy on Ast Prices
Katrin Asnmacher-Wesche∗
龙虾怎么烧Rearch Department
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Swiss National Bank
管理部Stefan Gerlach夸女人的成语
Institute for Monetary and Financial Stability
Johann Wolfgang Goethe University, Frankfurt
March 26, 2008
Abstract
This paper studies the respons of residential property and equity prices,
inflation and economic activity to monetary policy shocks in 17 countries,
using data spanning 1986-2006. We estimate VARs for individual economies
and panel VARs in which we distinguish between groups of countries on the
basis of the characteristics of their financial systems. The results suggest that
using monetary policy to offt ast price movements in order to guard
大名鼎鼎的意思against financial instability may have large effects on economic activity.
Furthermore, while financial structure influences the impact of policy on ast
prices, its importance appears limited.
Keywords: ast prices, monetary policy, panel VAR.
JEL Number: C23, E52
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∗The views expresd are solely our own and are not necessarily shared by the SNB. We are grateful to minar participants at the SNB and Petra Gerlach for helpful comments. Contact information: Katrin Asnmacher-Wesche (corresponding author): SNB, Börnstras 15, Postfach 2800, CH-8022 Zürich, Switzerland, Tel +41 44 631 3824, email: Katrin.Asnmacher-Wesche@snb.ch; Stefan Gerlach: IMFS, Room 101D, Mertonstras 17, D-60325 Frankfurt/Main, Germany, email: Stefan.Gerlach@wiwi.uni-frankfurt.de.
1. Introduction
There is much agreement that ast prices, in particular residential property prices, provide a crucial link through which adver macroeconomic developments can cau financial instability.1 Episodes of ast price “booms” are en as raising the risk of a sharp correction of prices, which could have immediate repercussions on the stability of financial institutions. Indeed, many obrvers have argued that property-price collaps have historically played an important role in episodes of financial instability at the level of individual financial institutions and the macro economy (e.g. Ahearn
e et al. 2005, Goodhart and Hofmann 2007a). Not surprisingly, this view has led to calls for central banks to react to movements in ast prices “over and beyond” what such changes imply for the path of aggregate demand and inflation (Borio and Lowe 2002, Cecchetti et al. 2000). Proponents of this policy emphasi that episodes of financial instability could depress inflation and economic activity below their desired levels. Conquently, they argue, central banks that ek to stabili the economy over a sufficiently long time horizon may need to react to current ast price movements (Bean 2004, Ahearne et al. 2005). Importantly, they do not argue that ast prices should be targeted, only that central banks should be willing to tighten policy at the margin in order to slow down increas in ast prices that are viewed as being excessively rapid in order to reduce the likelihood of a future crash that could trigger financial instability and adver macroeconomic outcomes.
While emingly attractive, this propod policy has implications for central banks' understanding of economic developments and for the effectiveness of monetary policy (Bean 2004, Bernanke 2002, Kohn 2006). First, central banks must be able to identify in real time whether ast prices are moving too fast or are out of line with fundamentals. Second, changes in policy-controlled interest rates must have stable and predictable effects on ast prices. Third, the effects of monetary policy
on different ast prices, such as residential property and equity prices, must be about as rapid, since stabilising one may otherwi lead to greater volatility of the other. Needless to say, if the criteria are not satisfied simultaneously, any attempts by central banks to offt ast price movements may simply
1The chapters in Hunter et al. (2003) provide an excellent overview of the interlinkages between monetary policy, ast prices and financial stability.
rai macroeconomic volatility, potentially increasing the risk of financial instability developing. Fourth, the size of interest rate movements required to mitigate ast price swings must not be so large as to cau economic activity and, in particular, inflation to deviate substantially from their desired levels since, if this were to be the ca, the resulting macroeconomic cycles could lead the public to question the central bank’s commitment to price stability. Fifth, the effects of monetary policy on ast prices must be felt sufficiently rapidly so that a tightening of policy impacts on ast prices before any bubble would burst on its own (since policy should then presumably be relaxed to offt the macro economic effects of the collap of the bubble).2
Of cour, it is by no means clear that central banks are better able to judge the appropriate level of
ast prices and the risk of future sharp price declines than agents transacting in the markets. It is equally unclear whether monetary policy has predictable effects on ast prices and, if so, whether the effects occur at about the same time horizons for different ast prices, whether they are large relative to the effects of monetary policy on inflation and economic activity and whether they occur faster. Thus, it is not clear that any of the five criteria are satisfied. In this paper we attempt to shed light on the issues by exploring the respons of residential property and equity prices, inflation and output growth to monetary policy shocks for a panel of 17 OECD countries using quarterly data for the period 1986-2006. The analysis proceeds in three steps. Following Iacoviello (2002) and Giuliodori (2005), we first estimate vector autoregressive models (VARs) for individual countries and study the impact of monetary policy on the economy.3Not surprisingly, the resulting estimates are impreci, leaving considerable uncertainty about the quantitative effect of changes in interest rates on ast prices relative to their impact on economic activity and inflation, as would em to be an important precondition for monetary policy to be ud to mitigate ast price movements. To rai the precision of the estimates, we thus follow Goodhart and
2Bean (2004) and Kohn (2006) discuss the implications of lags for the u of monetary policy in the face of ast price bubbles.
3Sutton (2002) and Tsatsaronis and Zhu (2004) also estimate VARs incorporating residential property prices for a range of countries. The focus of their studies, however, is on which factors explain movements in residential property prices and not on whether monetary policy is able to stabilize ast price movements.
Hofmann (2007b) and estimate a panel VAR incorporating real residential property and real equity prices. Our results show that while monetary policy does have important effects on ast prices, tho effects are not particularly large relative to tho it has on inflation and output. This suggests that attempts to stabili ast prices by using interest rate policy are likely to induce pronounced macroeconomic fluctuations.
However, while the panel estimates confirm that monetary policy has predictable effects on residential property prices, by construction the estimates disregard all country specific information. Since a number of authors have asrted that the transmission mechanism of monetary policy depends on the institutional characteristics of the financial system, we go on to split the sample of countries into two groups depending on their financial structure.4 We then estimate a panel VAR for each group and explore whether the impact of monetary policy on ast prices, inflation and output differs between the two groups. We u veral measures propod in the literature to capture differ
好久不见的英语ences in financial structure, including the importance of floating rate lending; whether mortgage equity withdrawal is possible; the loan-to-value ratio for new mortgages; the mortgage-debt-to-GDP ratio in the economy; the method ud to value property; whether mortgages are curitid; and the share of owner occupied dwellings. To preview briefly the results, we find that the financial structure does condition the respons of ast prices to monetary policy but also that the differences between country groups are less important than commonly thought.5
The paper is organid as follows. The next ction contains a discussion of the data and Section 3 prents the results for the VARs estimated for individual countries. In Section 4 we first briefly discuss panel VARs before discussing the estimates. Section 5 focus on the importance of financial structure and provides panel-VAR estimates when the countries are divided into two groups on the basis of financial structure. Finally, Section 6 concludes.
4The importance of financial structure of the economy is emphasized by so many authors that it is impossible to provide a full overview here. See, among others, Maclennan et al. (1998), Giuliodori (2005), Tsatsaronis and Zhu (2004), CGFS (2006) and Calza et al. (2007).
5See Maclennan et al. (1998) for a disnting opinion.
