The economic drivers of differences in house price inflation rates across MSAs

•Why does national interest rate policy affect house prices across MSAs differently?•Uni- and multivariate state-space models including interaction terms are estimated.•Interaction terms between MSA-level characteristics and monetary policy.•Impact of local demand/supply factors and monetary policy on house price inflation.•Price inflation is higher in MSAs with higher demand and tighter supply conditions.

This study examines why monetary policy at the national level can have vastly different effects on appreciation rates of single family houses across metropolitan statistical areas (MSAs). The study employs Case/Shiller monthly house price index data for 19 MSAs from 1992:06 to 2014:12 and FHFA quarterly house price index data for 94 MSAs from 1992:3 to 2014:4. We model the importance of MSA-specific demand and supply characteristics through a set of interaction terms between these factors and monetary policy. The empirical analysis is cast in terms of a state-space approach with a stochastic trend component to absorb the impact of omitted variables. Robustness checks use panel data estimators with interaction terms. A lower federal funds rate is associated with home price run-ups in MSAs that are characterized by higher demand and tighter supply conditions.