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Homework in Monetary Economics: Inflation, Home Production,

By Randall Wright, Larry Christiano, Marcello Veracierto, Yu Zhu and Gwen Eudey Aruoba


This paper introduces household production and the production of houses into a standard model of monetary exchange, and uses it to study the relationship between monetary policy and housing markets. Theory predicts inflation, as a tax on market activity, encourages substitution into household production, and thus encourages investment in houses. We show analytically that in the model the appropriately-deflated value of the housing stock is increasing with inflation or nominal interest rates. We show empirically that this is true in the data, using various sources for the U.S. and other countries. The calibrated model accounts for 20 to 50 percent of the observed relationships between home values and inflation or interest rates. It also implies that the cost of inflation is higher than predicted by models without home production. We thank many friends and colleagues for helpful input, especially Chrisophe Andre, Jef

Year: 2013
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