Housing, liquidity risk, and monetary policy

Abstract

There is increasing recognition that the effects of monetary policy are not symmetric across different sectors in the economy. For example, in recent empirical work, Givens and Reed (2018) focus exclusively on the capital goods sector and find that the impact of monetary policy on residential investment is more than twice as high as the behavior of fixed investment at the aggregate level. Why are the effects of monetary policy on residential investment so impactful compared to the overall capital sector? Further, what role do financial intermediaries play in promoting housing which is a significant component of personal wealth in the United States? To address the importance of housing for wealth accumulation, we study a model in which housing is traded across generations of individuals. Following Diamond and Dybvig (1983), individuals face stochastic liquidity preference shocks which impede housing accumulation. Intermediaries arise to help insure individuals against such idiosyncratic risk. However, inflation also limits the extent of risk-sharing. In this manner, the model follows recent contributions which emphasize that shocks to discount rates contribute to wealth inequality. Moreover, in contrast to one-sector monetary growth models, we demonstrate that it is important to disaggregate fixed investment between the residential and non-residential sectors to determine the effects of money growth. In particular, monetary policy will have asymmetric effects across the components of the overall capital stock.