The Effect of Monetary Policy on Residential and Structures Investment Under Differential Project Planning and Completion Times

Board of Governors of the Federal Reserve System International Finance Discussion Papers Number 671 July 2000 THE EFFECT OF MONETARY POLICY ON RESIDENTIAL AND STRUCTURES INVESTMENT UNDER DIFFERENTIAL PROJECT PLANNING AND COMPLETION TIMES Rochelle M. Edge NOTE: International Finance Discussion Papers are preliminary materials circulated to stimulate discussion and critical comment. References in publications to International Finance Discussion Papers (other than an acknowledgment that the writer has had access to unpublished material) should be cleared with the author or authors. Recent IFDPs are available on the Web at www.bog.frb.fed.us.

THE EFFECT OF MONETARY POLICY ON RESIDENTIAL AND STRUCTURES INVESTMENT UNDER DIFFERENTIAL PROJECT PLANNING AND COMPLETION TIMES Rochelle M. Edge* Abstract: This paper analyzes an empirical puzzle regarding the effect of monetary policy on fixed investment, specifically, why residential investment exhibits a strong and rapid response to changes in monetary policy while structures investment manifests a substantially weaker response. The paper proposes an explanation for these contrasting responses that is based on the differential planning and completion times of these two categories of investment as well as inflexibilities in changing the planned pattern of investment spending once the project has begun. Empirical support for the explanation is established by contrasting the responses of U.S. residential and structures building project starts and work undertaken to a monetary policy shock. The paper then shows that a calibrated sticky-price monetary business cycle model with multistage investment projects is capable of generating responses to monetary policy that are broadly consistent with those observed empirically. Keywords: transmission of monetary policy, residential investment, structures investment, time-to-build, time-to-plan. * Mailstop 23, Federal Reserve Board, Washington DC 20551, (202) 452 2339; FAX: (202) 736-5638; rochelle.m.edge@frb.gov. I wish to thank Ben Bernanke and Michael Woodford for their advice and helpful comments, John Landon-Lane, Nathan Porter, Argia Sbordone, Robert Shimer, Chris Sims and Mark Watson for comments on earlier versions of this paper, and Kosuke Aoki and Jean Boivin for helpful conversations. I express my considerable gratitude to Jeremy Rudd for all of his help. All errors are my own. The views in this paper are solely the responsibility of the author and should not be interpreted as reflecting the views of the Board of Governors of the Federal Reserve System or of any other person associated with the Federal Reserve System.

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# $ L( N( @+4(cid:3)(cid:17) ,N( .N(M | +8, |n(cid:129) ( | | ( N( | zkhuh (cid:17) dqg (cid:17) duh wkh udwhv ri ghsuhfldwlrq ri wkh pdunhw dqg krxvhkrog fdslwdo vwrfnv/ t (cid:21) (cid:22)( dqg N(cid:26)M U | (cid:26) ghvfulehv wkh dgmxvwphqw frvwv iru fkdqjlqj hdfk fdslwdo vwrfn1 Iroorzlqj | (cid:26) g(cid:26) | Kd|dvkl+4<;5,/wkhixqfwlrqM +=,lvdvvxphgwrkdyhwkhsurshuwlhvM +(cid:17) , @(cid:17) /M(cid:30)+(cid:17) ,@4/ (cid:26) (cid:26) (cid:26) (cid:26) (cid:26) (cid:26) dqgM(cid:30)(cid:30)+(cid:17) , (cid:23)31 Qrwhwkdwwkhhyroxwlrqhtxdwlrqvlpso|wkdwwkhfdslwdovwrfnlqdq|shulrg (cid:26) (cid:26) lv nqrzq dv ri wkh suhfhglqj shulrg1 q r " Wkh krxvhkrog fkrrvhv Ft>F(>(cid:127)|>Kt>K(>Nt >N( wr pd{lpl}h lwv xwlolw| | | (cid:27)| | | |n(cid:129) |n(cid:129) |’f +htxdwlrq +4,, vxemhfw wr lwv exgjhw frqvwudlqw +htxdwlrq +6,, dqg wkh fdslwdo hyroxwlrq htxdwlrqv ++7, dqg +8,,1 Wkh xwlolw|0pd{lpl}dwlrq sureohp |lhogv wkh iroorzlqj (cid:31)uvw0rughu frqglwlrqv iru wkh krxvhkrog=58 # $(cid:21) (cid:22) %# $(cid:21) (cid:22)& CF 4 CF 4 | @U (cid:15)H |n(cid:129) +9, CFt F S | | CFt F S | | | |n(cid:129) |n(cid:129) |n(cid:129) # $(cid:21) (cid:22) (cid:27)F CF P | @ | | +:, 4(cid:3)U3(cid:129) CFt S | | | (cid:19) (cid:20) # CF $(cid:21) 4 (cid:22) Kt .K( r @$h | +;, | | | CFt F | | (cid:19) Kt .K( (cid:20) r @ (cid:21) 4 (cid:22)# CF | $# CF | ( $ +<, | | F CF( CK( | | | % ## $ $ & U Nt H (cid:3) | M3(cid:129)(cid:30) |n(cid:129) (cid:3)+4(cid:3)(cid:17) , .h(cid:29) +43, | (cid:8) t Nt t |n(cid:129) % | # n(cid:129) # $ | $ ## $ $# $& Nt Nt Nt @ H M3(cid:129) |n2 (cid:3)+4(cid:3)(cid:17) , (cid:3)M3(cid:129)(cid:30) |n2 (cid:3)+4(cid:3)(cid:17) , |n2 | t Nt t t Nt t Nt |n(cid:129) |n(cid:129) |n(cid:129) 5 (cid:21) (cid:22)(cid:21) (cid:22)6 ## $ $ Y(cid:28)|n(cid:129) Y(cid:28) | ( n(cid:129) H 9 9(cid:3) U | M3(cid:129) (cid:30) N | ( n(cid:129) (cid:3)+4(cid:3)(cid:17) , . Y(cid:28) | ( (cid:21)n(cid:129) Y (cid:22) g | ( n(cid:129) : : +44, |7 (cid:8) ( N( ( 8 |n(cid:129) | Y(cid:28)|n(cid:129) Y(cid:28)t % ## $ $ ## $ |n(cid:129) $# $& N( N( N( @ H M3(cid:129) |n2 (cid:3)+4(cid:3)(cid:17) , (cid:3)M3(cid:129) (cid:30) |n2 (cid:3)+4(cid:3)(cid:17) , |n2 > | ( N( ( ( N( ( N( |n(cid:129) |n(cid:129) |n(cid:129) zkhuh wkh +jurvv, txduwhuo| lq dwlrq udwh lv= 58Lqzkdwiroorzv/dwloghryhudyduldeohglvwlqjxlvkhvwkhyduldeoh*vuhdoydoxhiurplwvqrplqdofrxqwhusduw1 45

S (cid:8) @ | = +45, | S |3(cid:129) Wkh (cid:31)uvw0rughu frqglwlrqv kdyh wkh vwdqgdug lqwhusuhwdwlrqv159 81415 Ilqdo0Jrrg Surgxfhuv Wkhuhsuhvhqwdwlyh(cid:31)qdo0jrrgsurgxflqj(cid:31)upxvhvdooriwkhgl(cid:30)huhqwldwhglqwhuphgldwhjrrgv wr surgxfh d frpsrvlwh (cid:31)qdo jrrg zklfk lv xvhg iru frqvxpswlrq dqg lqyhvwphqw1 Wkh surgxfwlrq ixqfwlrq iru \ wdnhv wkh vwdqgdug Gl{lw0Vwljolw} +4<::, irup= | (cid:21)] (cid:22) w (cid:129) w3(cid:129) w3(cid:129) \ @ \+}, w g} | | f zkhuh\ +},lvwkhtxdqwlw|riwkhgl(cid:30)huhqwldwhgjrrg} wkdwwkh(cid:31)qdo0jrrgsurgxfhughpdqgv | dqg (cid:21) lv wkh hodvwlflw| ri vxevwlwxwlrq lq surgxfwlrq1 Wkh (cid:31)qdo0jrrg surgxflqj (cid:31)up fkrrvhv i\+}, ; } 5 ^3>4‘j" vr dv wr plqlpl}h frvwv | |’f jlyhq wkh vhw ri sulfhv iS+}, ; } 5 ^3>4‘j" srvwhg e| wkh lqwhuphgldwh0jrrg surgxfhuv1 | |’f Wklv |lhogv d ghpdqg ixqfwlrq iru hdfk ri wkh lqwhuphgldwh jrrgv/ jlyhq e|= (cid:21) (cid:22) S+}, 3w \+}, @\ | = +46, | | S | Wkh ghpdqg ixqfwlrqv iru wkh lqwhuphgldwh jrrgv lpso| wkdw wkh frpshwlwlyh sulfh S iru | wkh (cid:31)qdo jrrg lv jlyhq dv= (cid:21)] (cid:22) (cid:129) S @ (cid:129) S+},(cid:129)3wg} (cid:129)3w = +47, | | f 81416 Lqwhuphgldwh0Jrrgv Surgxfhuv Wkh lqwhuphgldwh0jrrgv vhfwru lv frpsrvhg ri d frqwlqxxp ri prqrsrolvwlfdoo| frpshwlwlyh (cid:31)upvzkrhdfkkluhoderudqguhqwfdslwdofrpshwlwlyho|iurpwkhkrxvhkrogexwvhwwkhsulfh ri wkhlu gl(cid:30)huhqwldwhg jrrg vxemhfw wr wkh ghpdqg fxuyh wkdw wkh| idfh iru wkhlu surgxfw1 q r " Wkh lqwhuphgldwh0jrrgv surgxflqj (cid:31)upv hdfk fkrrvh K+}, >N+},t wr plqlpl}h | | |’f wkhlu surgxfwlrq frvwv jlyhq wkh iroorzlqj Free0Grxjodv surgxfwlrq ixqfwlrq= (cid:19) (cid:20) (cid:19) (cid:20) k E(cid:129)3k(cid:28) \+}, @ Nt+}, Kt+}, (cid:3)IF | | | 59Htxdwlrq +9, lv wkh lqwhuwhpsrudo LV htxdwlrq/ htxdwlrq +:, lv wkh OP htxdwlrq/ htxdwlrq +;, lv wkh krxvhkrog*v oderu vxsso| wr wkh pdunhw/ htxdwlrq +<, lv wkh oderu vxsso| wr grphvwlf surgxfwlrq/ htxdwlrq +43,gh(cid:31)qhvwkhkrxvhkrog*vvxsso|rifdslwdowrwkhpdunhwlqwkhiroorzlqjshulrg/dqghtxdwlrq+44,gh(cid:31)qhv wkh vxsso| ri fdslwdo wr grphvwlf surgxfwlrq lq wkh iroorzlqj shulrg1 46

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(cid:21) 4(cid:3)(cid:14) (cid:22) k 3 # ] (cid:129) (cid:21) S +}, (cid:22) 3w $ 3 w (cid:129) 4 (cid:21) (cid:29)h (cid:22) k Kt @ C\ | g} .IFD | +4:, | (cid:14) | S $h f | | (cid:21) (cid:14) (cid:22) (cid:129)3k 3 # ] (cid:129) (cid:21) S +}, (cid:22) 3w $ 3(cid:129) w 4 (cid:21) $h (cid:22) (cid:129)3k Nt @ C\ | g} .IFD | = +4;, | 4(cid:3)(cid:14) | S h(cid:29) f | | Zlwkdoo(cid:31)upvidflqjwkhvdphzdjhdqguhqwdoudwhv/hfrqrp|0zlghpdujlqdofrvwlvhtxdowr wkh pdujlqdo frvw ri dq lqglylgxdo (cid:31)up/ zklfk lv jlyhq e| htxdwlrq +48,1 Wkh hfrqrp|0zlgh sulfh ohyho lv ghwhuplqhg lq wkh (cid:31)qdo0jrrgv pdunhw e| htxdwlrq +47,1 81417 Prqhwdu| Dxwkrulw| Wkh prqhwdu| dxwkrulw| rshudwhv dffruglqj wr d prqhwdu| ihhgedfn uxoh wkdw lv lq wkh vslulw ri d (cid:19)Wd|oru uxoh1(cid:20) Vshfl(cid:31)fdoo|/ wkh prqhwdu| dxwkrulw| vhwv qrplqdo lqwhuhvw udwhv lq uhvsrqvh wr yduldwlrqv ri rxwsxw dqg lq dwlrq dzd| iurp wkhlu vwhdg|0vwdwh ohyhov/ exw dw wkh vdph wlph dlpv wr vprrwk pryhphqwv lq wkh lqwhuhvw udwh1 L xvh d prqhwdu| srolf| uxoh vlplodu wr wkh rqh hpsor|hg e| Ehuqdqnh/ Jhuwohu/ dqg Jlofkulvw +4<<<,1 Wklv uxoh lv gh(cid:31)qhg dv= (cid:19) (cid:20) U | @+U |3(cid:129) ,4 - \ | (cid:24) t(cid:8)(cid:24) | (cid:31) (cid:129)34 -h0|> +4<, zkhuh % uhsuhvhqwv wkh vwrfkdvwlf frpsrqhqw ri wkh uxoh1 | 81418 Pdunhw Fohdulqj D (cid:31)qdo frqglwlrq iru wkh prgho lv pdunhw fohdulqj/ wkdw lv/ wkh yroxph ri frqvxpswlrq dqg lqyhvwphqw xqghuwdnhq lq dq| shulrg pxvw eh htxdo wr wkh yroxph ri rxwsxw surgxfhg/ ru Ft .Lt .L( @\ = +53, | | | | 815 Htxloleulxp Htxloleulxp lv dq doorfdwlrq iFt/(cid:127)|/Kt/K(/Nt /N( /\ j" dqg d vhtxhqfh ri ydoxhv q r " | (cid:27)| | | |n(cid:129) |n(cid:129) | |’f (cid:8) /$h /(cid:29)h /U /PjF wkdwvdwlvi|htxdwlrqv +9, wr +44,dqg htxdwlrqv +47,wr+53,/ jlyhq |n(cid:129) | | | | |’f Nt/ N(/ (cid:8) / dqg U dqg wkh vhtxhqfh ri prqhwdu| vkrfnv i% j" 1 Wkh yduldeohv wkdw f f f 3(cid:129) | |’f frqvwlwxwh wkh htxloleulxp duh gh(cid:31)qhg vr dv wr hqvxuh wkdw wkhlu vwhdg|0vwdwh ydoxhv uhpdlq frqvwdqw ryhu wlph1 48

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3 4 (cid:129) # $ j % # $& LtW E LtW.LtW(cid:15) F Nt Ltc| @ (cid:129) E (cid:129) 2 F Nt H M3(cid:129) |n2 (cid:3)+4(cid:3)(cid:17) , (cid:129)c| LtW.LtW C (cid:19) (cid:20) 3j D |n(cid:129) | Nt t (cid:129) 2 LtW.LtW+(cid:15), (cid:129)3 (cid:129) j (cid:31)|n(cid:129) (cid:129)3j |n(cid:129) (cid:129) 2 -| +57, # $ (cid:21) (cid:22) L 2 t c c | | n(cid:129) @ L L 2 t t W W +(cid:15), (cid:129)3 (cid:129) j (cid:8) U |n(cid:129) (cid:129) 3 3 (cid:129) j L (cid:129) t c c | |= +58, (cid:129) | Jlyhq wkh glvwulexwlrq ri pdunhw lqyhvwphqw ryhu wkh wzr shulrgv/ wkh krxvhkrog wkhq fkrrvhv lwv ghvluhg shulrg w.5 fdslwdo vwrfn1 Wkh prgho lv vroyhg lq wkh vdph zd| dv lq wkhehqfkpdunfdvh/ zlwkkrxvhkrogxwlolw|+htxdwlrq+4,,pd{lpl}hg xqghu wkh krxvhkrog*v exgjhw frqvwudlqw/ qrz gh(cid:31)qhg dv= E .P (cid:23)U E .P .$ Kt .(cid:29) Nt .surilwv (cid:3)W (cid:3)S Ft (cid:3)S Ltc|(cid:3)S Ltc|(cid:3)S L( | | |3(cid:129) |3(cid:129) |3(cid:129) | | | | | | | | | (cid:129)c| | 2c| | | dqg wkh hyroxwlrq ri wkh wzr w|shv ri fdslwdo/ gh(cid:31)qhg lq htxdwlrqv +56, dqg +8,1 Wkh krxvhkrog*v (cid:31)uvw0rughu frqglwlrqv zlwk uhvshfw wr lwv fkrlfh ri Ft/ (cid:127)|/ Kt/ K(/ | (cid:27)| | | dqg N( duh lghqwlfdo wr wkh ehqfkpdun fdvh zkloh wkh krxvhkrog*v (cid:31)uvw0rughu frqglwlrq |n(cid:129) zlwk uhvshfw wr lwv fkrlfh ri H Nt lv qrz= | |n2 4. (cid:3)4 U U % 2 (cid:129) t t W W 4. U U 2 (cid:129) t t W W 4 (cid:15) # . (cid:129)3 (cid:129) j U U 2 (cid:129) t t (cid:19) W W (cid:31) (cid:15) - |n | (cid:129) (cid:20) (cid:129) 3 3 j j # (cid:8) $ U | & n | (cid:129) . L L 2 (cid:129) t t W W (cid:15) (cid:129)3 (cid:129) j (cid:21) (cid:8) U |n | (cid:129) (cid:22) (cid:129)3 (cid:129) j $ U Nt (cid:5) (cid:6) (cid:5)H |n(cid:129)M3(cid:129) (cid:30) |n2 (cid:3)+4(cid:3)(cid:17) , .H (cid:29)h | (cid:8) Nt t | |n2 3 |n2 4 |n(cid:129) # $ (cid:129) E 4 F LtW j @ C D 4. 2 (cid:15) 4. U U 2 t t W W L (cid:129) tW 5 (cid:129) 6 (cid:21) (cid:19) (cid:20) (cid:22) (cid:5)H 9 9 9 - (cid:31) | | n n (cid:129) 2 . U U 2 (cid:129) t t W W (cid:15) (cid:129)3 (cid:129) j - (cid:31) | | n n (cid:129) 2 (cid:129)3 (cid:129) j M3(cid:129) # N | t n(cid:12) (cid:3)+4(cid:3)(cid:17) , $: : : 3 |9 7 (cid:21) 4. 4 U U 2 (cid:129) t t W W (cid:15) (cid:129)3 (cid:129) j (cid:19) (cid:31) - | | n n 2 (cid:129) (cid:20) (cid:129) 3 3 j j (cid:22) j (cid:129) N | t n2 t : 8 # $ (cid:129) E 4 F LtW j (cid:3)C D 4. 2 (cid:15) +59, 4. U U 2 t t W W L (cid:129) tW (cid:129) 53

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E Orj0olqhdul}lqj wkh Prgho*v Htxloleulxp Frqglwlrqv E14 Orj0olqhdul}lqj wkh Ehqfkpdun Prgho Wkh krxvhkrog*v (cid:31)uvw0rughu frqglwlrqv +htxdwlrqv +9, wr +44,, orj0olqhdul}h73 wr= (cid:3)Fet .(cid:29) Nf( .(cid:29) Ke( | S+c&_ | S+c(cid:5)_ | @ Ue (cid:3)H Fet .(cid:29) Nf( .(cid:29) H Ke( (cid:3)(cid:8)e +64, | | |n(cid:129) S+c&_ |n(cid:129) S+c(cid:5)_ | |n(cid:129) |n(cid:129) (cid:21) (cid:22) 4 f Ue @Fet .(cid:3)(cid:29) Nf( (cid:3)(cid:29) Ke( (cid:3)Pi +65, UW(cid:3)4 | | S+c&_ | S+c(cid:5)_ | | # $ % # $ & KtW K(W v Ket .Fet (cid:3)(cid:29) Nf( . v (cid:3)(cid:29) Ke( @$eh +66, KtW.K(W | | S+c&_ | KtW.K(W S+c(cid:5)_ | | # $ % # $ & KtW K(W v Ket . v (cid:3)(cid:29) Ke( (cid:3)(cid:29) Fet (cid:3)(cid:29) Nf( @3 +67, KtW.K(W | KtW.K(W (cid:5)_c(cid:5)_ | (cid:5)_cS+ | (cid:5)_c&_ | (cid:29) (cid:30) (cid:29) (cid:30) 4 4 Ue (cid:3) (cid:8)e 4.(cid:15)(cid:17) (cid:3)(cid:15) | 4.(cid:15)(cid:17) (cid:3)(cid:15) |n(cid:129) t t M3(cid:129) (cid:30)(cid:30)+(cid:17), (cid:19) (cid:20) @ H (cid:29)eh . t (cid:15)H Nft (cid:3)+4.(cid:15),Nft .Nft +68, | |n(cid:129) 4.(cid:15)(cid:17) (cid:3)(cid:15) | |n2 |n(cid:129) | t (cid:29) (cid:30) (cid:29) (cid:30) 4 4 Ue (cid:3) (cid:8)e 4.(cid:15)(cid:17) (cid:3)(cid:15) | 4.(cid:15)(cid:17) (cid:3)(cid:15) |n(cid:129) ( ( @ +(cid:29) (cid:3)(cid:29) ,H Fet .+(cid:29) (cid:3)(cid:29) ,Nf( .+(cid:29) (cid:3)(cid:29) ,H Ke( &#_cS+ S+cS+ $ | |n(cid:129) &_c&_ S+c&_ |n(cid:129) &_c(cid:5)_ S+c(cid:5)_ | |n(cid:129) M3(cid:129) (cid:30)(cid:30)+(cid:17), (cid:19) (cid:20) . ( (cid:15)H Nf( (cid:3)+4.(cid:15),Nf( .Nf( +69, 4.(cid:15)(cid:17) (cid:3)(cid:15) | |n2 |n(cid:129) | ( zkhuh (cid:29) duh xwlolw| ixqfwlrq sdudphwhuv1 %c+ Wkh hfrqrp|*v idfwru ghpdqgv +htxdwlrqv +4:, dqg +4;,, olqhdul}h wr= (cid:29) (cid:30) \W Nft @ \e .+4(cid:3)(cid:14),$eh (cid:3)+4(cid:3)(cid:14),(cid:29)eh +6:, | \W.IF | | | 73Lq zkdw iroorzv d fduhw ryhu d yduldeoh vljql(cid:31)hv wkh yduldeoh*v orj0ghyldwlrq iurp lwv vwhdg|0vwdwh ydoxh zkloh d vwdu uhsuhvhqwv wkh vwhdg|0vwdwh ydoxh ri wkh yduldeoh1 68

(cid:29) (cid:30) \W Ket @ \e (cid:3)(cid:14)$eh .(cid:14)eh(cid:29) = +6;, | \W.IF | | | Wkhorj0olqhdul}dwlrqrihtxdwlrq+49,frpelqhgzlwkhtxdwlrq+47,lpso|wkdwghyldwlrqv ri wkh jurvv txduwhuo| lq dwlrq udwh iurp lwv vwhdg|0vwdwh ydoxh ri xqlw| hyroyh dffruglqj wr= (cid:29) (cid:30) +4(cid:3)(cid:16),+4(cid:3)(cid:16)(cid:15), g (cid:8)e @ PjF .(cid:15)(cid:8)e = +6<, | (cid:16) | |n(cid:129) Wkh prqhwdu| dxwkrulw|*v lqwhuhvw0udwh ihhgedfn uxoh +htxdwlrq +4<,, dqg wkh pdunhw0 fohdulqj frqglwlrq +htxdwlrq +53,, orj0olqhdul}h wr= Ue @(cid:29) Ue .+4(cid:3)(cid:29) ,! \e .+4(cid:3)(cid:29) ,! (cid:8)e .% +73, | - |3(cid:129) - + | - Z | | dqg (cid:21) (cid:22) (cid:21) (cid:22) 4(cid:3)(cid:17) 4 \e @ fFet .lt t Nft (cid:3)lt Nft +74, | | (cid:17) |n(cid:129) (cid:17) | (cid:21)t (cid:22) t (cid:21) (cid:22) 4(cid:3)(cid:17) 4 .+4(cid:3)f(cid:3)lt, ( Nf( (cid:3)+4(cid:3)f(cid:3)lt, Nf( (cid:17) |n(cid:129) (cid:17) | ( ( zkhuhfdqglt duhwkhvwhdg|0vwdwhvkduhvrirxwsxwghyrwhgwrfrqvxpswlrqdqglqyhvwphqw lq pdunhw fdslwdo1 E15 Orj0olqhdul}lqj wkh Prgho Lqwurgxflqj Wlph0wr0Exlog/ Wlph0wr0Sodq dqg H{0srvw Lqyhvwphqw Lq h{lelolwlhv Htxdwlrqv +59, dqg +5;, orj0olqhdul}h wr= ; < AA? AA@ 4 H (cid:29)eh @ (cid:21) (cid:21) (cid:22)(cid:22) +Ue (cid:3)(cid:8)e , | |n2 AA= 4.(cid:15) U 2 tW +4.(cid:15)(cid:17) (cid:3)(cid:15), AA> | |n(cid:129) UtW t ; (cid:129) (cid:21)(cid:21) (cid:22) (cid:22) < AA? 4.(cid:15)(cid:17) .(cid:15) U 2 tW (cid:3)4 AA@ . (cid:21) (cid:21) t (cid:22)(cid:22) U (cid:129) tW +H Ue (cid:3)H (cid:8)e , AA= 4.(cid:15) U 2 tW +4.(cid:15)(cid:17) (cid:3)(cid:15), AA> | |n(cid:129) | |n2 UtW t (cid:129) M3(cid:129)(cid:30)(cid:30)+(cid:17) , (cid:19) (cid:20) (cid:3) t (cid:15)H Nft (cid:3)+4.(cid:15),H Nft .Nft +75, +4.(cid:15)(cid:17) (cid:3)(cid:15), | |n(cid:12) | |n2 |n(cid:129) t 69

; (cid:21)(cid:21) (cid:22) (cid:22) < AA? 4.(cid:15)(cid:17) .(cid:15) U 2 tW (cid:3)4 AA@ H (cid:29)eh @ (cid:21) (cid:21) t (cid:22)(cid:22) U (cid:129) tW +Ue (cid:3)(cid:8)e , | |n(cid:129) AA= 4.(cid:15) U 2 tW +4.(cid:15)(cid:17) (cid:3)(cid:15), AA> | |n(cid:129) UtW t (cid:129) M3(cid:129)(cid:30)(cid:30)+(cid:17) , (cid:19) (cid:20) +(cid:30)(cid:3)4, (cid:3) t (cid:15)H Nft (cid:3)+4.(cid:15),Nft .Nft (cid:3) Letc| +4.(cid:15)(cid:17) (cid:3)(cid:15), | |n2 |n(cid:129) | +4.(cid:15)(cid:17) (cid:3)(cid:15), 2c| t (cid:21) (cid:22) (cid:21) (cid:22) t +(cid:30)(cid:3)4, 4 +(cid:30)(cid:3)4, 4(cid:3)(cid:17) . Nft (cid:3) t Nft> +76, +4.(cid:15)(cid:17) (cid:3)(cid:15), (cid:17) |n(cid:129) +4.(cid:15)(cid:17) (cid:3)(cid:15), (cid:17) | t t t t zkloh wkh pdunhw fohdulqj frqglwlrq +htxdwlrq +5<,, orj0olqhdul}hv wr= 3 4 3 4 UtW \e @ fFe .lt E C 4 F DLetc|.lt E C U 2 (cid:129) tW F DLetc| | | 4. U 2 tW (cid:129)c| 4. U 2 tW 2c| UtW UtW (cid:21)(cid:129) (cid:22) (cid:129) (cid:21) (cid:22) 4 4(cid:3)(cid:17) .+4(cid:3)f(cid:3)lt, Nf( (cid:3)+4(cid:3)f(cid:3)lt, ( Nf( (cid:17) |n(cid:129) (cid:17) | ( ( zkhuh 3 (cid:21) (cid:22) 4 Letc| @ (cid:21) 4 (cid:22) E E U U (cid:21) 2 (cid:129) t t W W (cid:15) (cid:22) F F (cid:19) Ue (cid:3)(cid:8)e (cid:20) . (cid:21) 4 (cid:22) H Nft (cid:3) (cid:21) 4(cid:3)(cid:17) t (cid:22) Nft (cid:129)c| (cid:30)(cid:3)4 C 4. U 2 tW (cid:15) D | |n(cid:129) (cid:17) t | |n2 (cid:17) t |n(cid:129) UtW (cid:129) 3 (cid:21) (cid:22) 4 3 (cid:21) (cid:22) 4 3 4 4. U 2 tW (cid:15) (cid:21) (cid:22) 4. U 2 tW (cid:15) (cid:21) (cid:22) Letc| @ E E (cid:21) U (cid:129) t (cid:22) W F F 4 Nft (cid:3) E E (cid:21) U (cid:129) t (cid:22) W F F 4(cid:3)(cid:17) t Nft . E E(cid:21) 4 (cid:22) F FLetc|3(cid:129)= 2c| C U 2 tW (cid:15) D (cid:17) t |n(cid:129) C U 2 tW (cid:15) D (cid:17) t | C U 2 tW (cid:15) D (cid:129)c|3(cid:129) UtW UtW UtW (cid:129) (cid:129) (cid:129) 6:

Table 1.1 - Average Project Completion Times for Nonresidential Buildings Value of Project (thousands) Average Number of Months from Start to Completion Standard Error $10,000 or more 24.7 - $5,000 to $9,999 17.4 0.2 $3,000 to $4,999 14.4 0.2 $1,000 to $2,999 11.4 0.2 $250 to $999 7.2 0.1 Less than $250 4.1 0.1 ALL VALUES 14.0 0.1 Table 1.2 - Average Project Completion Times for Residential Buildings Type of Project Share of Total Average No. of Months: Average No. of Months: Residential Investment* Permit Issue to Start Start to Completion Multifamily homes 19.5 to 21 percent 1.8 9.2 with 5 units or more Multifamily homes 2 to 3.5 percent 1.2 7.5 with 2 to 4 units Single-family homes 77 percent 0.7 6 TOTAL - 0.93 to 0.94 6.67 to 6.70 Figure 1.1 - Impulse Responses to a Monetary Policy Shock in the Different VAR Systems Panel (a) - Residential Investment (6 Lags) Panel (b) - Structures Investment (6 Lags) 1 1 0 0 -1 -1 -2 -2 -3 -3 0 12 24 36 48 60 0 12 24 36 48 60 Panel (c) - Residential Value Put in Place (6 Lags) Panel (d) - Structures Value Put in Place (6 Lags) 1 1 0 0 -1 -1 Federal Funds Rate System I Federal Funds Rate System II -2 -2 Nonborrowed Reserves System I Nonborrowed Reserves System II Federal Funds Market System -3 -3 0 12 24 36 48 60 0 12 24 36 48 60 ________________________________________________________________________ * The range of shares for multifamily homes with 5 or more units and multifamily homes with 2 to 4 units are based on the shares reported in the Housing Starts release (shares of total building projects started) as well the from the shares reported in the F. W. Dodge starts series (shares of total value of building starts). 38

Figure 1.2 - Responses to a Monetary Policy Shock in the VAR Models Structures Residential Single-Family Units Panel (a) - Federal Funds Rate I Panel (b) - Federal Funds Rate I Panel (c) - Federal Funds Rate I 1 1 1 0 0 0 -1 -1 -1 -2 -2 -2 -3 -3 -3 0 12 24 36 48 60 0 12 24 36 48 60 0 12 24 36 48 60 Panel (d) - Federal Funds Rate II Panel (e) - Federal Funds Rate II Panel (f) - Federal Funds Rate II 1 1 1 0 0 0 -1 -1 -1 -2 -2 -2 -3 -3 -3 0 12 24 36 48 60 0 12 24 36 48 60 0 12 24 36 48 60 Panel (g) - Nonborrowed Res. I Panel (h) - Nonborrowed Res. I Panel (i) - Nonborrowed Res. I 3 3 3 0 0 0 -3 -3 -3 -6 -6 -6 0 12 24 36 48 60 0 12 24 36 48 60 0 12 24 36 48 60 Panel (j) - Nonborrowed Res. II Panel (k) - Nonborrowed Res. II Panel (l) - Nonborrowed Res. II 1 1 1 0 0 0 -1 -1 -1 -2 -2 -2 -3 -3 -3 -4 -4 -4 -5 -5 -5 0 12 24 36 48 60 0 12 24 36 48 60 0 12 24 36 48 60 Panel (m) - Federal Funds Mkt. Panel (n) - Federal Funds Mkt. Panel (o) - Federal Funds Mkt. 1 1 1 0 0 0 -1 -1 -1 -2 -2 -2 -3 -3 -3 Value Put in Place -4 -4 -4 Starts -5 -5 -5 0 12 24 36 48 60 0 12 24 36 48 60 0 12 24 36 48 60 39

Figure 1.3 - Responses to a Monetary Policy Shock in the Benchmark Model Panel (a) - Nom. Interest Rates Panel (b) - Inflation Panel (c) - Real Interest Rates 0.5 0.2 1.4 1.2 0.4 0 1 0.3 -0.2 0.8 0.2 -0.4 0.6 0.4 0.1 -0.6 0.2 0 -0.8 0 0 4 8 12 16 20 0 4 8 12 16 20 0 4 8 12 16 20 Panel (d) - Output Panel (e) - Market Capital Panel (f) - Domestic Capital 0 0 0 -0.02 -0.02 -0.5 -0.04 -0.04 -1 -0.06 -0.06 -0.08 -0.08 -1.5 -0.1 -0.1 -2 -0.12 -0.12 0 4 8 12 16 20 0 4 8 12 16 20 0 4 8 12 16 20 Panel (g) - Consumption Panel (h) - Market Investment Panel (i) - Domestic Investment 0 1 1 0 0 -0.2 -1 -1 -0.4 -2 -2 -0.6 -3 -3 -0.8 -4 -4 0 4 8 12 16 20 0 4 8 12 16 20 0 4 8 12 16 20 Figure 1.4 - Effect of a Monetary Shock on Market Investment for Various Values of s 0 -1 -2 -3 M arket Investm ent (-10) M arket Investm ent (-1) M arket Investm ent (-0.1) Benchm ark m odel -4 0 1 2 3 4 5 6 7 8 40

Figure 1.5 - Responses of Market and Household Investment for Various Values of s 0 -1 -2 M arket Investm ent (-10) -3 M arket Investm ent (-1) M arket Investm ent (-0.1) Household Investm ent (-10, -1 & -0.1) -4 0 1 2 3 4 5 6 7 8 Figure 1.6 - Responses of Market Investment and Starts for Various Values of s 0 -1 -2 -3 M arket Investm ent (-10) M arket Investm ent (-1) M arket Investm ent (-0.1) M arket Starts (-10, -1 & -0.1) -4 0 1 2 3 4 5 6 7 8 Figure 1.7 - Responses of Starts of Market and Household Capital for Various Values of s 0 -1 -2 -3 M arket Starts (-10, -1 & -0.1) Household Starts (-10, -1 & -0.1) -4 0 1 2 3 4 5 6 7 8 41

Figure 1.8 - Responses of Starts and Investment in Market Capital 0 -0 .2 -0 .4 In v estm en t -0 .6 -0 .8 S ta rts -1 0 1 2 3 4 5 6 7 8 Figure 1.9 - Responses of Starts and Investment in Household Capital 0 -0 .5 -1 In v e stm e n t -1 .5 S ta rts -2 0 1 2 3 4 5 6 7 8 Figure 1.10 - Responses of Starts in Market and Household Capital 0 -0 .5 M a rk e t (S tru c tu re s) -1 -1 .5 H o u se h o ld (R esid en tial) -2 0 1 2 3 4 5 6 7 8 Figure 1.11 - Responses of Investment in Market and Household Capital 0 M a rk e t -0 .5 (S tru c tu re s) -1 -1 .5 H o u se h o ld (R e sid e n tia l) -2 0 1 2 3 4 5 6 7 8 42

Figure 1.12 - Impulse Responses - Theoretical Model and Federal Funds System I Panel (a) - Residential Value Put in Place Panel (b) - Structures Value Put in Place 2 2 1 1 0 0 -1 -1 -2 -2 -3 -3 -4 -4 0 2 4 6 8 0 2 4 6 8 Panel (c) - Residential Starts Panel (d) - Structures Starts 2 2 1 1 0 0 -1 -1 -2 -2 Augmented Standard -3 -3 Benchmark Error Bands VAR -4 -4 0 2 4 6 8 0 2 4 6 8 Figure 1.13 - Impulse Responses - Theoretical Model and Federal Funds System II Panel (a) - Residential Value Put in Place Panel (b) - Structures Value Put in Place 2 2 1 1 0 0 -1 -1 -2 -2 -3 -3 -4 -4 0 2 4 6 8 0 2 4 6 8 Panel (c) - Residential Starts Panel (d) - Structures Starts 2 2 1 1 0 0 -1 -1 -2 -2 Augmented Standard -3 -3 Benchmark Error Bands VAR -4 -4 0 2 4 6 8 0 2 4 6 8 43

Figure 1.14 - Impulse Responses - Theoretical Model and Nonborrowed Reserves System I Panel (a) - Residential Value Put in Place Panel (b) - Structures Value Put in Place 6 6 4 4 2 2 0 0 -2 -2 -4 -4 -6 -6 -8 -8 0 2 4 6 8 0 2 4 6 8 Panel (c) - Residential Starts Panel (d) - Structures Starts 6 6 4 4 2 2 0 0 -2 -2 -4 -4 Augmented Standard -6 -6 Benchmark Error Bands VAR -8 -8 0 2 4 6 8 0 2 4 6 8 Figure 1.15 - Impulse Responses - Theoretical Model and Nonborrowed Reserves System II Panel (a) - Residential Value Put in Place Panel (b) - Structures Value Put in Place 3 3 2 2 1 1 0 0 -1 -1 -2 -2 -3 -3 -4 -4 -5 -5 -6 -6 0 2 4 6 8 0 2 4 6 8 Panel (c) - Residential Starts Panel (d) - Structures Starts 3 3 2 2 1 1 0 0 -1 -1 -2 -2 -3 -3 -4 -4 Augmented Standard -5 -5 Benchmark Error Bands VAR -6 -6 0 2 4 6 8 0 2 4 6 8 44

Table 1.3 - Quasi-LM Statistics FFRI FFRII NBRI NBRII FFM* Residential Value Put in Place Benchmark Model 4675.89 4073.66 527.49 1152.51 638.72 Augmented Model 18.45 10.67 19.05 19.98 1.67 Residential Starts Benchmark Model 322.11 281.08 25.06 57.20 26.58 Augmented Model 32.75 31.32 26.99 29.62 2.72 Structures Value Put in Place Benchmark Model 2482.55 2162.61 291.60 634.79 130.39 Augmented Model 26.08 8.26 7.33 9.55 0.77 Structures Starts Benchmark Model 925.44 838.04 122.65 245.27 34.62 Augmented Model 13.04 11.37 8.27 8.30 0.81 Figure 1.16 - Structures Starts and Value Put in Place 170000 Structures Value Put in Place Structures Starts 150000 130000 110000 90000 70000 Jan-67 Jul-70 Jan-74 Jul-77 Jan-81 Jul-84 Jan-88 Jul-91 Jan-95 * The Quasi-LM statistics associated with the Federal funds market system of monetary policy identification are small due to the enormous standard error bands associated with the impulse response functions implied by this method of identification. 45