Monetary Policy and Housing Prices: An Analysis of the Official Bank Rate's Impact on Housing Price Development in Denmark

Cathrine Kaalstad & Maja Fornebo

Student thesis: Master thesis


This thesis aims to enlighten monetary policy’s impact on the historical housing price development in Denmark, with a particular focus on the official bank rate. The official bank rate constitutes the basis for other interest rates in a country, which make the central bank’s motivation for its determination a natural subject of investigation. In this regard, it is especially interesting to consider Denmark, as the Danish central bank conducts a fixed-exchange-rate regime against the euro. The analysis is conducted through a comparison approach with the application of quarterly input data for the estimation period reaching from the 1st quarter of 1973 to the 2nd quarter of 2017. The selected approach is executed through the determination of a proxy for the official bank rate to work as a benchmark for the market observed rate. The proxy rate is generated from the well-recognised Taylor rule, which should not be interpreted as a monetary rule in the economic theory sense, but rather a backward-looking method to evaluate previous interest rate behaviour. As the Taylor rule suggests that the official bank rate should be revised to stabilise inflation and output around their target values, it is implied that the estimated Taylor rate is a reflection of business cycles in Denmark. Although substantial deviations between the true official bank rate and the Taylor rate were detected, the Danish fixedexchange-rate policy is not considered threatened. This conclusion was reached mainly on the basis of improved alignment of the two interest rates after 1999, in addition to the benefits a fixed-exchange-rate policy brings to a small economy like Denmark. The applied housing price model does not include the official bank rate directly. Hence, constant relationships between the official bank rate and short- and long-term lending rates are assumed. This enables estimations of two housing price models that act identical except from a change in two isolated parameters, namely the short- and long-term lending rates. Deviations between the housing price developments predicted respectively by the proxy rate and the true official bank rate can thus exclusively be related to the indirect implementation of the Taylor rule. The estimation results evidenced minor differences between the two models. This underlines the fact that other factors work highly determinative in housing price approximations and that interest rates alone are not necessarily decisive for the outcome. The most significant findings revealed that the model that comprised housing price predictions based on the Taylor rule appeared more volatile and performed on an overall higher level than what was projected by the original housing price model. This behaviour was directly caused by the employment of the Taylor rule, which predicted a consistently lower official bank rate, especially prior to 1999.

EducationsMSc in Applied Economics and Finance, (Graduate Programme) Final Thesis
Publication date2018
Number of pages140