We examine the relative roles of fundamentals and psychology in explaining U.S. house price dynamics. Using metropolitan area data, we estimate how the house price-rent ratio responds to fundamentals such as real interest rates and taxes (via a user cost model) and availability of capital, and behavioral conjectures such as backwards-looking expectations of house price growth and inflation illusion. We find that user cost and lagged five-year house price appreciation rate are the most important determinants of changes in the price-rent ratio and lending market efficiency also is capitalized into house prices, with higher prices associated with lower origination costs and a greater use of subprime mortgages. We find no evidence in favor of behavioral explanations based on the one-year lagged house price growth rate or the inflation rate. The causes of a house price boom appear to vary over time, with interest rate fundamentals mattering more than backwards-looking price expectations in the house price run-up of the 2000s and vice versa during the 1980s boom.
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