House Prices and Government Spending Shocks
We show that a broad class of DSGE models with housing and collateralized borrowing predict a fall in house prices following positive government spending shocks. By contrast, we show that house prices in the US rise persistently after identified positive government spending shocks, using a structural vector autoregression methodology and accounting for anticipated effects. We clarify that the incorrect house price response is due to a general property of DSGE models—approximately constant shadow value of housing—and that modifying preferences and production structure does not help in obtaining the correct house price response. We then show that the effect on house prices is positive only when monetary policy strongly accommodates government spending shocks. The model, however, does not deliver a persistent rise in house prices. Properly accounting for the empirical evidence on government spending shocks and house prices using a DSGE model therefore remains a significant challenge.