An even more troublesome fallacy is that people tend to confuse price levels with rates of price change. They think that arguments implying that home prices are higher in one country than another are also arguments that the rate of increase in those prices should be higher there.
OPPOSITE
But the truth may be just the opposite. Higher home prices in a given country may tend to create conditions for falling home prices there in the future.
The kinds of expectations for real estate prices that have informed public thinking during the recent bubbles were often totally unrealistic. A few years ago Karl Case and I asked random home buyers in US cities undergoing bubbles how much they thought the price of their home would rise each year on average over the following 10 years. The median answer was sometimes 10 percent a year. If one compounds that rate over 10 years, they were expecting an increase of a factor of 2.5, and if one extrapolates, a 2,000-fold increase over the course of a lifetime. Home prices cannot have shown such increases over long time periods, for then no one could afford a home.
The sobering truth is that the current world economic crisis was substantially caused by the collapse of speculative bubbles in real estate (and stock) markets — bubbles that were made possible by widespread misunderstandings of the factors influencing prices. These misunderstandings have not been corrected, which means that the same kinds of speculative dislocations could recur.
Robert Shiller is professor of economics at Yale University and chief economist at MacroMarkets LLC.
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