Joint Adjustment of House Prices, Stock Prices and Output Towards Short-run Equilibrium

A dynamic IS-LM model including houses and stocks as additional assets will be analysed in this paper. Providing also housing services, a major consumption item for most households, houses create an additional link between the monetary and the real sector, distinct from the traditional wealth effect channel. We analyse the adjustment path of output, house prices and stock prices after policy shocks within a rational expectation setup. Depending crucially on the elasticity of housing services demand, different reaction patterns of asset prices will emerge. The results are contrasted with relevant empirical findings, particularly Lastrapes (Journal of Housing Economics, 11 (2002), pp. 40-74), leading to the identification of plausible elasticity ranges. The analysis sheds new light on the ongoing discussion about demand effects from changing real estate wealth and about determinants of house price fluctuations. Copyright Blackwell Publishers Ltd and the Board of Trustees of the Bulletin of Economic Research, 2006.