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The Federal Reserve should pay more attention to home prices when it sets monetary policy, a leading academic said Monday.
In a new research paper circulated by the National Bureau of Economic Research, Michael Woodford, an economics professor at Columbia University, said housing prices are a good indicator of private-sector expectations of monetary policy and should be tracked to see if the Fed’s interest-rate strategy is on course.
The central bank should “lean against” housing prices: being tighter when housing prices unexpectedly rise and easier when prices surprisingly fall.
House prices have climbed rapidly of late, up nearly 7% in the 12 months ending February, according to the Case-Shiller 20-city composite.
At the moment, policy prescriptions like the well-known Taylor rule have traditional target variables only for inflation and the output gap. In his paper, Woodford suggests that a new variable for housing prices be added to the Fed’s policy rule.
Woodford said he “does not pretend to provide a complete analysis of the problem of a desirable policy response to house booms and busts.”
The question of how monetary policy should react to housing prices and other potential asset bubbles has been much debated since the 1990s. Former Fed Chairman Alan Greenspan had the view that the Fed should be prepared only to clean up after asset bubbles burst because it was difficult to spot them early enough.
Some experts have argued the Fed should have tightened policy faster in the face of the housing market bubble in the early 2000s.
After the collapse of the housing market bubble in 2007-2008 and the subsequent financial crisis, the Greenspan view has been discredited. Fed officials have pledged to be more proactive but there is still a debate about whether interest rates or regulatory measures are the best way to combat frothy asset markets.
“The bulk of the profession is leaning toward using regulatory tools” such as loan-to-value requirements and capital requirements on banks to combat asset bubbles, noted Joe Gagnon, a former Fed staffer now at the Peterson Institute of International Economics.
The Federal Open Market Committee, the central bank’s policy arm, is now briefed once-per-quarter on the behavior of asset prices.
Woodford said the Fed shouldn’t get caught up trying to distinguish between “fundamental” and “nonfundamental” movements in housing prices.