Abstract
We assess the role of housing price movements in influencing the optimal design of monetary policy. Even though the relationship between liquidity constraints and consumption behavior is well documented in the empirical and theoretical literature, little attention has been paid to credit frictions at the household level in the monetary business cycle literature. This paper represents the first attempt to evaluate welfare-based monetary policy using a model with heterogeneous agents and credit constraints at the household level. In evaluating optimal monetary policy, we take advantage of recent advances in computational economics, by adopting the approach of Schmitt-Grohe and Uribe (2003). Our results indicate that under an optimally designed simple monetary policy rule, housing price movements should not be a separate target variable in addition to inflation. Furthermore, the welfare loss arising from targeting housing prices becomes quantitatively more significant the higher the degree of access to the credit market.