In reviewing the asset price cycles that occurred in the 1980s in the United States and Japan, it appears that the effects of excessively expansionary monetary policies were more highly concentrated in real estate markets than is usually the case during an economic boom. The principal aim of this paper is to test the hypothesis that monetary policy affected real estate prices differently in the 1980s than it did in the 1970s. A model of price-determination is developed in which the equilibrium price of real estate relative to a more general price index is influenced by various demand and supply factors, including real income and cost variables, monetary policy variables, and expectations. Various empirical representations of the model are estimated using maximum-likelihood techniques under different assumptions about both the role of expectations and the model’s dynamic structure.
The estimated equations suggest that monetary policy variables were important determinants of the relative price of real estate in the United States and Japan, and that there was a structural break in both countries in the 1980s. In particular, the results indicate that interest rates became a statistically more significant determinant of real estate values. Moreover, the within-sample predictions of the model indicate that the relative price of real estate would have increased less in the United States, and adjustments would have been less volatile in Japan, had the structural break not occurred.