Local governments’ indebtedness and its impact on real estate prices

Abstract

This paper estimates the causal effect of public debt on real estate prices and rental prices. We identify shocks to debt of self-governed cities in Germany and control for potential benefits such as an increased supply of public goods, which may come together with increased indebtedness. Using spatial variation across self-governed cities, we can quantify the causal effect. We find that shocks to public debt capitalise into property prices, questioning the presence of debt illusion in Germany. Rental prices, on the other hand, do not seem affected by public debt but by the actual tax burden, indicating that renter illusion does not reflect an illusion but rational behaviour.