By Birol Kanik and Wei Xiao
We explore the possibility that a housing market boom-bust cycle may arise when public beliefs are driven by news shocks. News, imperfect and noisy by nature, may generate expectations that are overly optimistic or pessimistic. Over-optimism easily leads to excessive accumulation of housing assets, and creates a housing boom that is not based on fundamentals. When the news is found false or inaccurate, investors revert their actions, and a downturn in the housing market follows. By altering agents’ net worth conditions, a housing cycle can have significant repercussions in the aggregate economy. In this paper, we construct a dynamic general equilibrium model that can give rise to a news-driven housing boom-bust cycle, and we consider how monetary policies should respond to it.
What the abstract does not mention is that the news shocks does not pertain directly to the housing market. The mechanism is as follows. Positive news about increase expected future net worth, which raise aggregate demand, include housing. The higher house prices relax borrowing contraints as houses are used as collateral, which amplifies the total effect. We have thus an amplifier running entirely on news.