Working Paper: CEPR ID: DP6183
Authors: Markus K. Brunnermeier; Christian Julliard
Abstract: A reduction in inflation can fuel run-ups in housing prices if people suffer from money illusion. For example, investors who decide whether to rent or buy a house by simply comparing monthly rent and mortgage payments do not take into account that inflation lowers future real mortgage costs. We decompose the price-rent ratio in a rational component ? meant to capture the proxy effect and risk premia ? and an implied mispricing. We find that inflation and nominal interest rates explain a large share of the time-series variation of the mispricing, and that the tilt effect is very unlikely to rationalize this finding.
Keywords: behavioral finance; housing; inflation; illusion; interest rate; money illusion; mortgages; real estate
JEL Codes: G12; R21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| reduction in inflation (E31) | increase in housing prices (R31) |
| inflation (E31) | housing prices (R31) |
| money illusion (E41) | housing prices (R31) |
| inflation (E31) | mispricing component of price-rent ratio (R31) |
| mispricing component of price-rent ratio (R31) | housing prices (R31) |
| inflation decreases (E31) | future real mortgage costs decreases (G21) |