Housing Market Vulnerabilities and Monetary Policy: Lessons From two Decades of European Data

Abstract

This paper investigates the transmission of monetary policy to real output, inflation, and housing markets in twelve European countries over the period 1995Q1-2025Q2. The paper emphasizes the importance of housing markets in the transmission mechanism of monetary policy and calls for a forward-looking policy approach that incorporates housing-related vulnerabilities into central bank decision-making. The study employs a pooled panel Vector Autoregression model with sign restrictions to identify the effects of both interest rate and money supply (M3) shocks, as well as a combined policy mix. The results confirm that housing markets constitute a central channel through which monetary policy shocks affect the real economy. Real house prices demonstrate the most significant and enduring responses, exceeding those observed in output and general price levels. Furthermore, the analysis reveals asymmetries in the transmission mechanism: contractionary shocks generate larger and longer-lasting effects than expansionary ones, particularly in the housing sector. These findings underscore the disproportionate impact of restrictive monetary policies and the associated risks for affordability, wealth distribution, and financial stability. The study concludes that housing dynamics should be more systematically integrated into monetary and macroprudential policy frameworks, especially in light of the persistent vulnerabilities linked to ultra-low interest rates and money supply expansions.