Money Illusion and Housing Frenzies

A reduction in ination can fuel run-ups in housing prices if people su¤er from money illusion. For example, investors who decide whether to rent or buy a house simply comparing monthly rent and mortgage payments do not take into account that ination lowers future real mortgage costs. We decompose the price-rent ratio in a rational component meant to capture proxy e¤ect and risk premia and an implied mispricing. We \u85nd that ination and nominal interest rates explain a large share of the time-series variation of the mispricing, and that the tilt e¤ect is unlikely to rationalize this \u85nding