Working Paper: NBER ID: w12810
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 unlikely to rationalize this finding.
Keywords: money illusion; housing prices; inflation; mispricing; economic psychology
JEL Codes: G12; R21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| money illusion (E41) | mispricing (D49) |
| inflation (E31) | mispricing (D49) |
| nominal interest rates (E43) | mispricing (D49) |
| mispricing (D49) | housing prices (R31) |
| inflation (E31) | housing prices (R31) |
| inflation (E31) | price-rent ratio (R31) |