During the late 1970s, U.S. house prices were appreciating rapidly even though mortgage interest rates were climbing. Recently, interest rates have eased but prices have moderated. This study examines the role of appreciation expectations in overcoming the negative effects of nominal mortgage interest rates on house prices. Expectations of future appreciation are important determinants of house sales prices, remaining influential during periods of declining and moderating real prices, not just when prices are rising. The real rate of interest, as viewed by the homebuyer, is the mechanism for affecting change in housing price levels. Because the nominal interest rate is slow to reflect changes in expectations, these real rates vary over time. This ebb and flow of real interest rates appears to explain market price levels. Nominal rates play a role as well, primarily in the formation of appreciation expectations.
Hendershott, Patric H. and Sheng, Cheng Hu. Inflation and Extraordinary Returns on Owner-Occupied Housing: Some Implications for Capital Allocation and Productivity Growth. Journal of Macroeconomics 3 (1981), 177203.
We develop a model of staggered prices along the lines of Phelps (1978) and Taylor (1979, 1980), but utilizing an analytically more tractable price-setting technology. Demands are derived from utility maximization assuming Sidrauski-Brock infinitely-lived families. We show that the nature of the equilibrium path can be found out on the basis of essentially graphical techniques. Furthermore, we demonstrate the usefulness of the model by analyzing the welfare implications of monetary and fiscal policy, and by showing that despite the price level being a predetermined variable, a policy of pegging the nominal interest rate will lead to the existence of a continuum of equilibria.
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