In light of the steep increase of home prices and rents in Israel in 2009–2010, we identified and quantified the macroeconomic variables that influenced these prices between 1999 and 2010. Estimating an error-correction model and a difference equation model, we found that the monetary interest rate cut in response to the global economic crisis was the main reason for the steep increase in home prices in 2009–2010. An additional factor, although to a lesser degree, was the shortage in dwellings. An interest rate cut of one percentage point led to a 6.5 percent increase in home prices over approximately two years. Monetary policy also had a significant impact on home prices during the years 2004–2007, before the current economic crisis. Hence, monetary policy affects home price movement, and this movement

may also be an indicator for the extent to which monetary policy is expansionary or restrictive with respect to financial stability. Consequently, monetary policy decision makers should consider its effect on home prices. The models generate a forecast for six quarters, and thus support the decision making process at the Bank of Israel on a regular basis.

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