The effect of monetary policy on housing: a factor-augmented vector autoregression (FAVAR) approach

Abstract

This study examines the link between monetary policy and the housing market. The analysis is conducted using impulse response functions derived from a factor-augmented vector autoregression (FAVAR) model. The FAVAR methodology as developed by Bernanke et al. (2005) avoids the degrees of freedom problem present in standard vector autoregression (VARs) models. The estimations are conducted using 120 macroeconomic time series in monthly frequency for the period January 1959 to August 2001. Results indicate that housing starts respond negatively to monetary policy shocks. This result is consistent across regions in the United States. In the case of housing permits and mobile home shipments, the response to a monetary policy shock is positive at first, but becomes negative after a few periods.