It has long been shown that most of the major market fluctuations have been predisposed to certain degree of market disequilibrium as advocated by Soros himself which the rational expectation model fails in explaining such phenomenon. With reference to the classical properties cycle as it has happened in US now, the market is spurred by growing optimism that has yet to be justified in the initial phase of such cycle. In other words, people are not solely buying on valuation basis but most importantly on the perception that they could reap attractive capital gains from their property arbitrages. This exerts an upward pressure on the property prices as a result of the underlying demand for properties itself.
Morever, it has also created a spilled over effect on the demand for their factors of production (ie raw material, labour and utility overhead) and hence causing their respective prices to rise in an upward spiral. Producers may even slow or control the production of these factors of production in anticipation of future price hikes that would eventuate some day. This is often self-perpetuating to such an extent that it exacerbates the rate of inflation growing in the near future. The inflationary effect attributed from the demand for properties and the cost pressure from building materials, labour wages and rising utility overhead further create a multiplier effect on the prices of goods and services across the board until prices reach to a level that could not be sustained anymore. Eventually, inflation will take its toll on the everyday living of the people.
Most central banks might even rise their key interest rate in order to keep the inflationary environment under control. The interest rate hikes itself may erode both realised and unrealised capital gains from property arbitrages because of the fact that home owners are made to shoulder additional mortgage charges in excess of what they really could afford. They might even find that these arbitrages are becoming harder and harder to execute as the liquidity of property market runs dry; a typical situation when prices rise too fast and too steep.
Inflation by itself will act as an implicit tax to our tax payers' pocket in the sense that it forces them to pay more for the usual basket of goods and services then before. It dampens consumer spending and affects growth in an economic system at large. If the inflation condition has coincided with a slow down in economic growth as we might experience right now (as a result of the situation mentioned above), recession will eventually set in.
At this point, this is where the investment and consumption confidence of the people collapse giving way to relentless price cuts in attempt to entice more deals in an already growth stifled environment. On the other hand, people will hoard more cash for future contingencies and less on consumption spending and investment; as a classical instance where rational expectation plays out a self-adjusting and reinforcing process on peoples' consumption and investment behaviour. Cost cutting measures are also put in place in order to enhance the competitiveness of economies in the production of goods and services. As peoples' ability to produce cheaper goods and services increases, this enables them to accumulate more wealth in terms of their ability to churn out greater value of good and services for the economy. This in turn translates into greater purchasing power for the people while the inflation condition is therefore reversed paving the way to a sustained economic recovery.