Can an unexpected jump in inflation change real interest rates differently depending on how mortgages are structured?

Details

This paper examines the general equilibrium effects of both anticipated and unanticipated inflation shocks when an asset such as housing is financed through long-term contracts. Unlike other analyses of housing and mortgage finance, the model assumes that financial markets are fully integrated.

The analysis uses a simple three-period overlapping generations model. Agents obtain a mortgage in the first period and maximize utility subject to a constraint that they cannot borrow for consumption. Economic simulations under rational expectations trace the transition paths of endogenous interest rates, house prices, and welfare after inflation shocks.

When nominal contracts prevail, an unexpected increase in inflation causes the real interest rate to decline because of adjustments in the loanable funds market. These real effects arise even without tax distortions or explicit modelling of uncertainty. The paper contrasts these real effects under adjustable-rate mortgages with their absence under price-level-adjusted mortgages.