Effects of inflation on the housing market under rational expectations

In this study an equilibrium asset-market model of the housing market is developed. The model is used to examine the effects of inflation on the Australian housing market under the maintained hypothesis of rational expectations. It provides a theoretical basis for empirically testing several hypotheses about the effects of inflation, however, the scarcity of relevant and reliable data is an important limitation, and the results are of consequential significance only. Two streams of literature that have emerged from American research in this area are drawn together in the present study and, to that end, the theoretical model presented herein serves as a useful extension and adaptation of previous models. Specifically, attention is directed to the influence of inflation on current housing demand decisions through: the characteristics of the mortgage instrument; the institutional features of the mortgage market; and the user-cost of home ownership. Generation of the testable hypotheses necessiates a brief discourse on the evidence of a 'Fisher effect' in the determination of nominal interest rates in Australia. Some simple experiments are performed in an attempt to provide empirical evidence, consistent with previous cited research, of the absence of such an effect.