Understanding the Prevalence and Implications of Homeowner Money Illusion

Abstract

Money illusion, the tendency to favor nominal values over more economically relevant real values, is argued to be the source of real estate bubbles causing unnecessary instability in the economy. We examine the existence of money illusion in a residential real estate setting as well as its implications for forming future price expectations and subsequent home purchase and mortgage selection decisions. We find that while money illusion is quite prevalent, it can be mitigated by presenting an analysis in economic, as opposed to affective, terms.

Keywords: money illusion, false reference points, residential real estate, forecasts, expectations.

JEL Classification: C83, D03, E49, G02, R00