Homework in Monetary Economics: Inflation, Home Production and Production of Homes
S. Boragan Aruoba, Morris A. Davis and Randall Wright ,
Review of Economic Dynamics

We introduce household production and the production of houses (construction) into a monetary model. Theory predicts infl‡ation, as a tax on market activity, encourages substitution into household production and hence investment in housing. In the model, the stock and appropriately-de‡flated price of housing increase with infl‡ation or nominal interest rates. We document this in data for the U.S. and other countries. A calibrated model accounts for up to 52% (87%) of the relationship between interest rates and housing wealth defl‡ated by nominal output (by the money supply).

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