Homework in Monetary Economics: Inflation and House Prices
We study how perfectly anticipated inflation affects allocations and prices in a new-monetarist model with a home-production sector. Inflation taxes market production but not home production, since cash is essential for some market transactions but is not necessary to enjoy home-produced goods. In response to inflation, households substitute activity from the taxed sector (market) to the untaxed sector (home). Since housing is an input to home production, people accumulate housing in response to inflation. If housing is not perfectly elastically supplied, due to the presence of a fixed factor such as land in the production of new housing, the price of housing rises. We document a strong positive relationship between house values and consumer price inflation present in post-war U.S. data and investigate the degree to which our model can replicate this and other facts.
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