Non-technical summary of ESM Working Paper 59 "The housing supply channel of monetary policy"

Housing markets play a central role in many economies—as illustrated by the impact of their collapse during the Global Financial Crisis of 2007–09. Housing and construction activity are also very sensitive to changes in interest rates and therefore are often strongly affected by monetary policy. Interestingly, regional housing markets react very differently to changes in monetary policy.   

The paper focuses on the relevance of differences in housing supply constraints across US states for the transmission of monetary policy to regional housing markets, economic activity, and the financial sector. We find that in states with very constrained housing supply, where land-use restrictions are relatively tight, the housing market and the broader economy respond more strongly to changes in monetary policy. When interest rates go up, these areas experience on average a stronger fall in house prices as housing demand weakens. There is also a larger slowdown in economic activity more generally, and an increase in financial stability risks, leading to a larger deterioration of banks’ financial health. Moreover, we also observe a stronger shift of demand from the owner-occupied segment to the rental segment of the housing market in areas where housing supply is more constrained. Finally, differences in private sector indebtedness across states also seem to play a role for the impact of monetary policy and may potentially interact with—or amplify the role of—housing supply constraints.   

Our results have implications for policymakers. If housing markets, economic activity, and the financial sector are indeed more negatively affected by rising interest rates in areas with constrained housing supply, financial supervision and macroprudential authorities should monitor developments in these areas more closely to detect and limit risks early on. In addition, relaxing land-use restrictions could make an area less prone to boom-bust cycles in house prices, and thus should help make an economy more resilient to contractionary demand shocks.