Document Type

Working Paper

Publication Date

9-8-2021

Abstract

Housing markets are closely related to monetary policy. This paper studies the link between housing frictions and the effectiveness of forward guidance. A housing collateral constraint and forward guidance shocks are incorporated into a standard medium-scale New Keynesian Dynamic Stochastic General Equilibrium (DSGE) model. Our main results produce a number of important implications. First, financial frictions emanating from the housing market dampen the effectiveness of forward guidance on the economy. Second, forward guidance has asymmetric effects on the welfare of lenders and borrowers when housing frictions increase. Housing frictions also attenuate the effect of forward guidance at the zero lower bound. Finally, this article provides a solution to "forward guidance puzzle" of Del Negro et al. (2012). Thus, policymakers should consider housing frictions when examining the effects of forward guidance on the economy.

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