TY  - JOUR
AU  - Piazzesi,Monika
AU  - Schneider,Martin
TI  - Inflation Illusion, Credit, and Asset Pricing
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 12957
PY  - 2007
Y2  - March 2007
UR  - http://www.nber.org/papers/w12957
L1  - http://www.nber.org/papers/w12957.pdf
N1  - Author contact info:
Monika Piazzesi
Department of Economics
Stanford University
579 Serra Mall
Stanford, CA 94305-6072
Tel: (650) 723-9289
E-Mail: piazzesi@stanford.edu

Martin Schneider
Department of Economics
Stanford University
579 Serra Mall
Stanford, CA 94305-6072
Tel: (650) 721 6320
E-Mail: schneidr@stanford.edu
M3  - presented at "Asset Prices and Monetary Policy Conference", May 5-6, 2006
AB  - This paper considers asset pricing in a general equilibrium model in which some, but not all, agents suffer from inflation illusion. Illusionary investors mistake changes in nominal interest rates for changes in real rates, while smart investors understand the Fisher equation. The presence of smart investors ensures that the equilibrium nominal interest rate moves with expected inflation. The model also predicts a nonmonotonic relationship between the price-to-rent ratio on housing and nominal interest rates -- housing booms occur both when the nominal rate is especially low and when it is especially high. In either situation, disagreement about real interest rates between smart and illusionary investors stimulates borrowing and lending and drives up the price of collateral. The resulting housing boom is stronger if credit markets are more developed. We document that many countries experienced a housing boom in the high-inflation 1970s and a second, stronger, boom in the low-inflation 2000s.
ER  -