But I never actually reversed the argument. After all, why should tight money lead to bubbles? Wouldn’t you expect more real estate bubbles during periods when inflation is pushing house prices higher at a rapid rate? Perhaps, but as Kevin points out it’s real house prices that matter. Even so, perhaps real house prices might be expected to go up during periods of high inflation, as houses are a sort of inflation hedge.
But Kevin noticed a powerful force pushing the other way. In America mortgage debt is commonly structured so that monthly payments stay constant over 30 years. This means that during periods of high NGDP growth, when nominal interest rates are also high, monthly payments will start very high in real terms, and then fall rapidly in real terms. But your ability to qualify for a house depends on how large the initial nominal monthly payment is, relative to your current income.
This means that average people will have much more difficult time qualifying for a mortgage when both nominal GDP growth and nominal interest rates are relatively high. As a result, real estate “bubbles” are more likely to occur during periods when nominal interest rates are relatively low and average people find it easier to qualify for mortgage loans. I initially missed this point because I focused too much on the Fisher effect and not enough on the strange practice in America of structuring mortgage payments in nominal terms.
In this blog I frequently focused on two types of money illusion, downward wage rigidity and nominal debt. Sticky wages lead to unemployment when nominal GDP falls. Nominal debt leads to debt crises when nominal GDP falls. And now we have a third, monthly mortgage payments that are stable in nominal terms lead to real estate booms when nominal interest rates are relatively low. And of course nominal interest rates are relatively low when nominal GDP is relatively low. And of course slow nominal GDP growth is an indication of tight money.