Credit and M2 may be driven simultaneously as part of a broader financial intermediation process; a common underlying factor may be the interest rateMoney supply ; Credit ; Housing - Prices

Yi Wen

English

Research Papers in Economics

Economic SYNOPSES
short essays and reports on the economic issues of the day
2010 ■ Number 6
S
hould monetary policy be concerned about housing
price inflation? Housing prices are affected by the
credit supply because housing purchases are financed
by borrowing. When home demand goes up, housing prices
also increase. On the other hand, the cost of borrowing
depends on nominal interest rates, which in turn may be
influenced by monetary policy.
Economists often define inflation as changes in the price
level of all commodities currently produced (the gross
domestic product deflator) or consumed (the consumer
price index [CPI]). Neither measure explicitly includes
housing prices because housing purchases are considered
investments rather than consumption. Rental prices are
included in the CPI; however, they do not fully reflect hous-
ing prices for at least two reasons: (i) The rental market is
relatively thin, so rental rates and housing prices do not
necessarily follow each other closely; and (ii) during
“bubble” periods many people buy
houses for investment purposes rather
than as primary residences. This creates
a wedge between rental rates and hous-
ing prices. The lack of strong correla-
tion between rental rates and housing
prices is evidenced by greater volatility
in housing prices than in the present
value of future rents.
It is well known that the housing
market strongly leads the business
cycle. One reason is that home pur-
chases (especially new home purchases)
increase aggregate demand by increas-
ing the demand for durable goods
(such as furniture, home appliances,
flooring materials, and so on). Because
housing prices tend to rise with a rise
in the rate of home purchases, it is
reasonable to assume that home
prices and the real economy are well
connected.
The chart, which uses post-World War II U.S. data,
shows 10-year moving averages of various indicators, includ-
ing the growth rate of M2 (the black line on the chart). M2
money stock is composed of currency, travelers checks,
demand deposits, checking accounts, savings deposits, small-
denomination time deposits, and retail money funds. The
chart also shows housing price inflation, measured as the
median price of existing homes (the dark blue line), new
single-family homes (the light blue line), and CPI inflation
(the gray line). The 10-year moving average captures longer-
Money Supply, Credit Expansion, and 
Housing Price Inflation
Yi Wen, Assistant Vice President and Economist
Credit and M2 may be driven 
simultaneously as part of a broader
financial intermediation process; 
a common underlying factor 
may be the interest rate. 
10-Year Moving Average
0
2
4
6
8
10
12
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
Percent Change
M2
Median New Single-Family Home Price Inflation
Median Existing Home Price Inflation
CPI Inflationterm relationships for the time series, including a close
relationship between (i) money growth and either measure
of housing price inflation and (ii) housing inflation and
CPI inflation until around 2000. In particular, the steady
increase in the housing price inflation rate since the early
2000s is closely associated with the steady increase in the
money supply during the same period. Overall, housing
price inflation appears to lead CPI inflation.
The chart does not provide any causal relationships
among the series. M2 is mostly endogenous, determined
more or less simultaneously with credit via financial inter-
mediation. However, credit and M2 may be driven simulta-
neously as part of a broader financial intermediation process;
a common underlying factor may be the interest rate. A
lower interest rate may stimulate borrowing and housing
demand, which in turn may induce higher demand for
durable goods. Because durable goods are purchased with
money, the demand for money may also increase. As a result,
aggregate demand and the money supply may increase,
which raises the aggregate price level. Therefore, policy-
makers may want to closely watch housing price inflation,
not only because it leads CPI inflation, but also because an
overheated housing market may encourage more risk-taking
behaviors by banks and cause the aggregate money supply
to increase, resulting in excess aggregate demand and higher
inflation risk. ■
Economic SYNOPSES Federal Reserve Bank of St. Louis      2
research.stlouisfed.org
Posted on March 5, 2009
Views expressed do not necessarily reflect official positions of the Federal Reserve System.

Money supply, credit expansion, and housing price inflation

http://research.stlouisfed.org/publications/es/10/ES1006.pdf

Money supply, credit expansion, and housing price inflation

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