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Uncertainty and Housing in a New Keynesian Monetary Model with Agency Costs

This paper demonstrates that risk (uncertainty) along with the monetary (interest rates) shocks to thehousing production sector that is subject to nominal frictions in prices and wages are a quantitativelyimportant impulse mechanism for the business and housing cycles. Our model framework is that ofthe housing supply/banking/monetary sector model as developed in Dorofeenko, Lee, Salyer and Strobel(2016) with the model of housing demand with sticky pricing (Calvo) presented in Iacoviello and Neri(2010). We provide empirical evidence that large housing price and residential investment boom and bustcycles over the last few years are driven largely by economic fundamentals and financial constraints. Wefind the impact of risk and monetary shocks are the main impulse in explaining the aggregate and sectoralfluctuations. Moreover, in the presence of nominal frictions in prices and wages, the Loan to Value ratiothat affects the household borrowing constraint plays a critical role for real aggregate variables. Thiscomparison carries over to housing market variables such as the price of housing, the risk premium onloans, and the bankruptcy rate of housing producers.