Distinction between bubble and fundamental price change So far we haven’t made any assumption about the source of a house price increase. It could be fundamentally justi…ed or it could be driven by non-fundamental factors.
Whether this matters for the model depends on the expectations of the young borrowers and the middle-aged lenders about the persistence of the house price boom. If both expect it to last at least until the next period borrowers and lenders are happy to accept the value of the house as collateral even though at some point in time it might fall considerably. This again results from the role of housing as collateral, which allows to bring forward consumption from later periods. Under this view it doesn’t matter whether consumers believe house prices are driven by fundamental or non-fundamental factors.
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